"Soaring inflation and record market highs may leave investors wondering whether it’s time to adjust their portfolios. Researchers have examined a wide range of timing strategies based on considerations such as earnings, dividends, interest rates, and economic growth. A recent Morningstar report showed that investors may be better off steering clear of tactical asset allocation strategies and avoiding making short-term shifts among asset classes."
After touching record highs in early January, US stocks have slumped, and investors have been confronted with worrisome headlines in the financial press:
“Giant Stock Swings Send Some Into Bear Territory”
- Gunjan Banerji and Peter Santilli, The Wall Street Journal, 18 Jan 2022
Some stocks that attracted intense interest last year have fallen sharply from their previous highs, as Exhibit 1 shows.
Is rising inflation a negative for equity investors? Do large losses in a handful of popular stocks signal a downturn ahead for the broad market?
Invariably, the question behind the question is: “Should I be doing something different in my portfolio?” This is just another version of the market timing question dressed in different clothes. Should I sell stocks and wait for a more favourable outlook to buy them back? More precisely, can we find clear trading rules that will tell us when to buy or hold stocks, when to sell, when to admit our mistakes, and so on?
The lure of successful trading strategies is seductive. If only we could find them, our portfolios would do so much better.
Consider Felicity Foresight. She is gifted with the ability to identify patterns in the champagne bubbles floating to the top of her glass on New Year’s Eve, enabling her to predict the best performer between S&P 500 stocks and US Treasury bills over the subsequent 12 months. How would her hypothetical portfolio have performed over the past 50 years following this simple annual readjustment strategy?
Rather well. Following a Perfect Timing strategy by investing in the best performer each year, she turned $1,000 into $1.8 million, nearly 10 times the wealth produced using a buy-and-hold strategy for the S&P 500 Index (see Exhibit 2).
But also consider Hapless Harry. He was never a fan of New Year’s and manages to get it wrong each and every year. His Perfectly Awful strategy winds up losing money over the same 50-year period.
Motivated by the substantial payoff associated with successful timing, researchers over the years have examined a wide range of strategies based on analyses of earnings, dividends, interest rates, economic growth, investor sentiment, stock price patterns, and so on.
One colourful example, known as the Hindenburg Omen, had a brief moment of fame in 2010. Developed by a blind mathematician and former physics teacher, this stock market indicator took its name from the German airship disaster of 1937. The Omen signalled a decline only when multiple measures of 52-week high/low prices and moving averages all turned negative. This indicator had correctly foreshadowed major downturns in 1987 and 2008. When it flashed a “sell” signal on Thursday, August 12, 2010, internet chat rooms and Wall Street trading desks were buzzing the next day, Friday the 13th, with talk of a looming crash, according to The Wall Street Journal. But no crash occurred, and the S&P 500 had its highest September return since 1939.
The money management industry is highly competitive, with more stock mutual funds and ETFs available in the US than listed stocks. If someone could develop a profitable timing strategy, we would expect to see some funds employing it with successful results. But a recent Morningstar report suggests investors should be wary of those claiming to do so. The report examined the results of two types of funds, each holding a mix of stocks and bonds:
- Balanced: Minimal change in allocation to stocks
- Tactical Asset Allocation: Periodic shifts in allocation to stocks
As a group, funds that sought to enhance results by opportunistically shifting assets between stocks and fixed income underperformed funds that simply held a relatively static mix (see Exhibit 3). Morningstar further pointed out that if the performance of non-surviving tactical funds were included, the numbers would be even worse. Its conclusion: “The failure of tactical asset allocation funds suggests investors should not only stay away from funds that follow tactical strategies, but they should also avoid making short-term shifts between asset classes in their own portfolios.”
We should not be surprised by these results. Successful timing requires two correct decisions: when to pare back the allocation to stocks, and when to increase it again.
Watching a portfolio shrink in value during a market downturn can be discomforting. But investors seeking to avoid the pain by temporarily shifting away from their long-term strategy may wind up trading one source of anguish for another. The initial upsurge in prices from their lows often takes many investors by surprise, and they find it extraordinarily difficult to buy stocks that were available at sharply lower prices a few weeks earlier.
The opportunity cost can be substantial: Over the 25-year period ending in 2021, a hypothetical $100,000 invested in the stocks that make up the Russell 3000 Index would have grown to $1,036,694. But during this quarter-century, missing just the best consecutive 90-trading-day period (which ended June 22, 2020) shaved the ending wealth figure by an alarming 33%.
Add to this the likelihood of increased transaction costs and the potential tax consequences of a short-term trading strategy, and the odds of adding value through market timing grow even slimmer.
As a thoughtful financial advisor once observed: “A portfolio is like a bar of soap. The more you handle it, the less you have.”
This article was originally published by Dimensional Fund Advisors.
Dimensional Fund Advisors is a fund management company with an investment strategy that is based on economic theory and backed by empirical data. They take an evidence-based approach towards security prices and focus on consistent implementation of portfolio design and management.
Endowus currently includes several Dimensional Funds as part of its Core portfolios, such as the Global Core Equity Fund, the Emerging Markets Large Cap Core Equity Fund and the Pacific Basin Small Companies Fund. To explore Fund Smart options on Endowus, click here.
Dimensional Fund Advisors disclaimer
The information in this document is provided in good faith without any warranty and is intended for the recipient’s background information only. It does not constitute investment advice, recommendation, or an offer of any services or products for sale and is not intended to provide a sufficient basis on which to make an investment decision. It is the responsibility of any persons wishing to make a purchase to inform themselves of and observe all applicable laws and regulations. Unauthorised copying, reproducing, duplicating, or transmitting of this document are strictly prohibited. Dimensional accepts no responsibility for loss arising from the use of the information contained herein.
“Dimensional” refers to the Dimensional separate but affiliated entities generally, rather than to one particular entity. These entities are Dimensional Fund Advisors LP, Dimensional Fund Advisors Ltd., Dimensional Ireland Limited, DFA Australia Limited, Dimensional Fund Advisors Canada ULC, Dimensional Fund Advisors Pte. Ltd., Dimensional Japan Ltd., and Dimensional Hong Kong Limited. Dimensional Hong Kong Limited is licensed by the Securities and Futures Commission to conduct Type 1 (dealing in securities) regulated activities only and does not provide asset management services.
This material is deemed to be issued by Dimensional Fund Advisors Pte. Ltd., which is regulated by the Monetary Authority of Singapore and holds a capital markets services license for fund management.
This advertisement has not been reviewed by the Monetary Authority of Singapore. This information should not be considered investment advice or an offer of any security for sale. All information is given in good faith without any warranty and is not intended to provide professional, investment, or any other type of advice or recommendation and does not take into account the particular investment objectives, financial situation, or needs of individual recipients. Before acting on any information in this material, you should consider whether it is suitable for your particular circumstances and, if appropriate, seek professional advice. Dimensional Fund Advisors Pte. Ltd. does not accept any responsibility and cannot be held liable for any person’s use of or reliance on the information and opinions contained herein. Neither Dimensional Fund Advisors Pte. Ltd. nor its affiliates shall be responsible or held responsible for any content prepared by financial advisors.
Investment involves risk. Past performance is not necessarily a guide to future performance or returns. The value of investments and the income from them can go down as well as up, and you may not get the full amount you invested. Rates of exchange may cause the value of investments to go up or down. Individual stock performance does not represent the return of a fund.
Any forward-looking statements, prediction, projection or forecast on the economy, stock market, bond market or economic trends of the markets contained in this material are subject to market influences and contingent upon matters outside the control of Endow.us Pte. Ltd (“Endowus”) and therefore may not be realised in the future. Further, any opinion or estimate is made on a general basis and subject to change without notice. In presenting the information above, none of Endowus Pte. Ltd., its affiliates, directors, employees, representatives or agents have given any consideration to, nor have made any investigation of the objective, financial situation or particular need of any user, reader, any specific person or group of persons. Therefore, no representation is made as to the completeness and adequacy of the information to make an informed decision. You should carefully consider (i) whether any investment views and products/ services are appropriate in view of your investment experience, objectives, financial resources and relevant circumstances. You may also wish to seek financial advice through a financial advisor or the Endowus platform and independent legal, accounting, regulatory or tax advice, as appropriate.
Investment into collective investment schemes: Please refer to respective funds’ prospectuses for details of the funds, their related fees, charges and risk factors, The listing of units of the fund on a stock exchange does not guarantee a liquid market for the units. Before making an investment decision, you are reminded to refer to the relevant prospectus for specific risk considerations.
For Cash Smart Secure, Cash Smart Enhanced, Cash Smart Ultra: It is not a bank deposit and not capital guaranteed, and is subject to investment risks, including the possible loss of the principal amount invested. Investment products are not insured products under the provisions of the Deposit Insurance and Policy Owners Protection Schemes Act 2011 of Singapore and are not eligible for deposit insurance coverage under the Deposit Insurance Scheme. Interest rates are indicative and subject to change at any time.
Product Risk Rating: Please note that any product risk rating (the “PRR”) provided by us is an internal rating assigned based on our product risk assessment model, and is for your reference only. The PRR is subject to change from time to time. The PRR does not take into account your individual circumstances, objectives or needs and should not be regarded as advice or recommendation to purchase, hold or sell the any fund or make any other investment decisions. Accordingly, you should not solely rely on the PRR in making your investment decision in the relevant Fund.
This advertisement has not been reviewed by the Monetary Authority of Singapore.