In an ideal world, you could sense when a large and sustained shift in market direction is approaching. This ability would allow an investor to own risky assets when markets are moving higher and sell ahead of large drawdowns. Unfortunately, the world does not work this way. 

Every day, millions of buy and sell decisions made by investors incorporate known information and expectations for the future into stock prices. This makes the market an incredibly efficient mechanism for pricing stocks in a manner that balances the negative views of those that are selling with the positive views of those that are buying. The price for an investment at any given point in time represents the equilibrium level that balances those opposing views.

By the time you read the Wall Street Journal or turn on CNBC, the news and opinions discussed have reached a wide audience and are already being discounted in prices. Making investment decisions based on publicly available information is unlikely to be profitable because the price move you are trying to take advantage of has likely already occurred. To profit, a forecast of the future must be more accurate than the cumulative knowledge of millions of other investors. The likelihood of doing this consistently is incredibly low, but that does not stop investors from trying to outsmart the market.

“Investing is not a game where the guy with the 160 IQ beats the guy with the 130 IQ. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing.” - Warren Buffet

The table below provides some context on the potential cost of market timing. The column on the far left represents the growth of $1,000 invested in the S&P 500 from 1990 through the end of last year. Throughout the 32-year period, stocks returned an average of 9.75% per year return, and the initial investment would have grown a staggering $21,555. That figure alone does a lot to demonstrate the wealth-creating ability of the stock market for investors that can stick to their plans. To achieve that 21x growth on invested assets, you would have had to of held tight through:

• The 9/11 terrorist attacks
• The wars in Iraq and Afghanistan
• The technology stock bubble bursting and the recession
• The housing market bubble bursting and Financial Crisis
• The US Government Debt downgrade
• The trade war with China
• The pandemic and recession
• Multiple Federal Reserve tightening cycles

Source: Dimensional Fund Advisors. In US dollars. For illustrative purposes. Best performance dates represent start of period. The missed best consecutive days examples assume that the hypothetical portfolio fully divested its holdings at the end of the day before the missed best consecutive days, held cash for the missed best consecutive days, and reinvested the entire portfolio in the S&P 500 at the end of the missed best consecutive days. Annualized returns for the missed best consecutive days examples were calculated by substituting actual returns for the missed best consecutive days with zero.

S&P data © 2023 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. “One-Month US T- Bills” is the IA SBBI US 30 Day TBill TR USD, provided by Ibbotson Associates via Morningstar Direct. Data is calculated off rounded daily index values.

The remaining blue bars in the chart illustrate what would have happened had an investor missed out on some of the best periods. As you can see, the ending value of wealth falls precipitously as the length of the missed period increases. An investor could have been perfectly disciplined for 31 of the 32 years, but if they sat out of the market for that one strong year, their ending wealth would have been nearly cut in half!

What are the chances of actually missing out on one of these strong periods? If you are prone to deviating from your plan, it is probably higher than you think. In investing, there is a concept known as ‘volatility clustering.’ This means that large price swings up and down tend to be grouped close to each other. As a result, an investor that sells risky assets and moves to cash when the market is volatile may avoid further losses, or they may end up missing some (or all) of the subsequent recovery.

Notice the dates of the best periods from the table above:

• Best Week (11/21/2008): Occurred during the peak of the Financial Crisis, shortly after the failure of Lehman Brothers.
• Best Month (3/10/2009): The initial recovery from the Financial Crisis
• Best 3 Months (3/24/2020): The initial recovery from the pandemic selloff
• Best 6 Months (3/10/2009): Recovery from the Financial Crisis 
• Best Year (3/24/2020): Recovery from the pandemic selloff

The ‘best periods’ occurred in or around some of the most volatile market episodes of the past few decades. This poses an interesting challenge. To time the market successfully, an investor must be correct twice. They must know when to sell and then when to buy back in. Neither is easy. 

Most investors sell after it is apparent the economy and the market are in trouble. Typically, prices have already moved materially lower by this point. Getting back into the market may be the harder of the two decisions. There will never be an all-clear signal to alert investors when it is safe to buy back in. Recoveries can be swift. After reaching the bottom on 3/23/2020, the S&P 500 rallied approximately 17% in just three trading days! Recoveries can also be long and grinding. For years after the Financial Crisis, investors were skeptical about the longevity of the rally and continued to call for a double-dip recession. Of course, those calls proved to be misguided, and the market went on to enjoy one of the longest bull markets on record.

Investors that sit on the sidelines waiting for the perfect entry point can remain there for an extended period. Since the stock market generally rises over time, forgoing these gains can represent a significant opportunity cost. Ultimately, when it comes to growing your wealth, time in the market trumps timing the market.

Week in Review

• According to FactSet, 18% of the S&P 500 has reported Q2 results as of last Friday’s close. The earnings growth rate, blended between companies that have already reported with the estimates for those that have yet to report, is at -9.0% year-over-year. Expectations for the earnings growth rate at the onset of earnings season was -6.7% year-over-year. If earnings growth remained at this level, it would be the worst YoY earnings growth figure since Q2 of 2020. 
• It will be a busy week for economic data. Items to be published this week includes the S&P Case-Shiller Home Price Index and consumer confidence on Tuesday. On Wednesday, we’ll get new home sales. Thursday will have jobless claims, durable goods orders, the first reading on Q2 GDP, and pending home sales. Friday will include the Personal Consumption Expenditures (PCE) Index, which is the Fed’s preferred gauge of inflation. We will also get an updated reading on the Employment Cost Index, which is the Fed’s preferred measure of wage gains. The Fed is watching the labor market, and wages in particular, for signs that inflation pressures may be easing in a sustainable way.
• In addition to the above economic data releases, the Fed will conclude its next meeting on monetary policy this Wednesday. After hiking rates following ten consecutive meetings, the Fed kept its benchmark federal funds rate unchanged at 5.00% to 5.25% in June. The market is currently pricing in a 0.25% increase on Wednesday as a near certainty. The market will be searching for clues on what the Fed might do next. The market is pricing in no additional hikes after this week, with cuts beginning by March of 2024. If the Fed pushes back on that expectation in the post-meeting statement or press conference, you could potentially see some volatility. 

Hot Reads

Markets

• Why the Fed Isn’t Ready to Declare Victory on Inflation (WSJ)
• How Financial Crises Shaped the Federal Reserve – Video (WSJ)
• Home Prices Continue to Climb With ‘Striking’ Regional Differences, Says S&P Case-Shiller (CNBC)

Investing 

• Rich and Anonymous (Morgan Housel)
• How to Invest Like the 1% (Ben Carlson)
• The Cruel Irony of Investing (Michael Batnick)

Other

• Stuck on a Flight? Know Your Rights During a Tarmac Delay (WSJ)
• British Open 2023: The Secret to Good Putting? Look at Brian Harman’s Stats (Golf Digest)
• What Was The Manhattan Project? (Scientific American)

Markets at a Glance

Source: Morningstar Direct.

Source: Morningstar Direct.

Source: Treasury.gov

Source: Treasury.gov

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

Economic Calendar

Source: MarketWatch

IMPORTANT DISCLOSURE INFORMATION