Market Timing – Does it work?
“Rule No. 1: Never lose money. Rule No. 2: Never forget rule No. 1.” – Warren Buffett
The S&P 500 hit a -10% correction level and most of the gains are gone for the year. It took 3 weeks to lose all the unrealized gains that were made over the last 40 weeks. Everyone in equities lost money, even Warren Buffett. He probably lost the most money out of anyone. His quote should serve more as an investing mindset on how to invest. If you invest or buy something overvalued your losses will likely be permanent. If you gamble or buy something you don’t understand, you will never dig out of the hole. What Buffett’s quote means to me is that you need to understand your risk profile, time horizon, and most important, what your capacity to take a loss is. Capacity is how much can you afford to lose without falling short of your goals. As bad as it as been, all of my clients are still on a path to meet and exceed their goals.
Buffett can never lose. He bet on America and the only way he loses is if we all have to go out and buy guns. If markets fall, he has enough cash to buy at discount prices. If markets rise, his investments will chug right along. The key to his strategy is holding enough cash to buy investments for the long-term. These 10% corrections are very common. This is the second one just this year. The first one was already long forgotten and this one will be a distant memory, I’d say in about the next 6 months. The only way a portfolio will never recover is if this rule was violated or there isn’t enough cash to dollar cost average into a stock that was bought at too high a price.
For all my clients nearing retirement or that have lower risk profiles, I wrote a few weeks ago that I had increased cash and bonds. I sold before the sell-off and bought t-bills. For a few clients that are in retirement and have a much lower capacity for loss, I reallocated into more bonds. This begs the question am I timing the market?
My strategy is not market timing, but having the mindset of Buffett’s quote. I can’t time the market because I have no idea what the market will do in the next day, week, or month. All I know is that I’m well prepared for whatever happens next. I have cash to buy at lower prices. For my younger clients just starting to invest, I always remind them that they prefer falling markets to rising markets. For older clients, they all want stability and to own solid investments. There is no stability to this market right now, but it should return very soon. There comes a point in time when prices fall so low that you will need much worse economic news to reach the dreaded -20% correction. We are at or near that level where prices are looking attractive as long as the economy continues to grow above 2%. At this time, GDP is the highest it’s been in years and unemployment is at its lowest level. Markets would have a much harder time recovering if people were out of work and companies were not hiring. I believe the reason for this sell-off is that markets became slightly overvalued and China and Europe’s economies are slowing.
The stock market is not the only real asset that is losing value. The same goes for the housing market. I expect that house prices will soon cool in price. The home-building stocks have been hit the hardest. I’m not going to make a prediction for when the market will recover or even stop falling. The future direction of the market will be determined by what happens next in overseas markets. The losses need to stop piling up in Europe and Emerging Markets. These indices are now down -12% and -16% year-to-date, respectively. This could happen next week or next year, but it should be sooner rather than later. There could also be a boost after the midterm elections when that uncertainty is removed. We are in a similar pattern to what happened after the last election. Markets moved higher once people understood what the policies of the government were going to be for the next two years. I’m ready for either a Democrat or a Republican to lead the government. My investments should do well long-term under either party. If you buy high quality stocks at rock-bottom prices, you will do well over time. The one thing that would turn me even more cautious is if I start reading about corporate layoffs. As long as people can keep paying their mortgages, this correction should prove to be another great buying opportunity.
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