H.ERE IS A. Good investment advice that you normally won’t find in any tip sheet, newsletter, or “thoughtful” weekly column on capital markets. It is from Will Rogers, a popular interwar American entertainer and joke, on the writings of Paul Samuelson, a Nobel Prize winner and joke of post-war America. Are you ready? Here it is. You should buy stocks when they go up. If they fall, sell them.
Good job if you can get it, Samuelson quipped. It’s a shame few can. The idea of timing the market – all highs, no lows – remains seductive, however. Everyone who invests in stocks has at one time or another imagined that they could sell up and buy down in order to enjoy the returns on stocks while avoiding the risks. It seems easy. When stocks are expensive and investors look careless, the market should be left. When it falls behind, as it surely needs to be, fill your boots.
A lot is being thought about right now. The cyclically adjusted price-earnings ratio (CAPE) Ratio, a measure of value constructed by Robert Shiller of Yale University, was rarely higher. The combination of social media and inexpensive retail investor trading apps is what drives a lot into fashion stocks, a sign of top py markets. In such circumstances it is tempting to try to outsmart the herd. However, market timing is more difficult than it looks. Few have the ability, temperament, or focus to do this profitably.
Stock prices are loud. The axiom used to be that they are a random walk: your current levels say nothing about where you are going. A less puristic view has emerged since then. This says the yield on income – the reverse of the CAPE– is a decent guide to expected stock returns over the longer term. Put simply, high stock prices now mean lower returns in the future. At the present time CAPEAs in the late 1920s and late 1990s, the expected returns are well below the long-term average (see chart).
Those keen eyes will notice that whenever stock prices have risen much faster than profits, they will fall back again. Future market timers, however, could not have known exactly when to sell. It’s never obvious that CAPE is near a top or bottom. Timing studies led by valuation metrics like the CAPE show disappointing results when compared to buying and holding stocks for long. Selling too early is a big problem. As Samuelson, who wrote extensively on the dangers of timing, once said: “Anything can be carried on to the point where it has already been reached.” When the market craters it is not so easy to trade. It takes nerves to buy when everyone is selling. Delay seems wise. Prices could keep falling. The fate of many market timers is to buy back stocks at prices higher than those at which they were sold.
Despite the low expected returns today, stocks are still attractive because of the low returns in other asset markets. In the late 1990s when the CAPE Over 40, the yield on inflation-linked government bonds rose to almost 4%. Today it’s -1% on the ten-year bond. When low real interest rates are the mainstay of stock prices, any attempt to time the stock market is essentially a bet on the bond market – and in turn on how inflation will develop and how central banks will react to it. Good luck with the right calls. The forces behind decades of declines in real interest rates and dormant inflation are not well understood even by people who have spent considerable time thinking about them.
It is difficult for most investors to judge if, when, and how quickly these worldly trends will reverse. Yes, there is something crazy about negative real bond yields. In America they are a novelty. But in Europe and Japan, they took a lot longer than many people thought possible. Agnosticism about your future path is probably the best policy.
It would be nice to have highs without lows. However, returns on investments are generally associated with risk. The advice of market timing skeptics like Samuelson is of the nut-apple pie type. Sell your inventory to sleep point where you can easily rest at night. Spread your bets widely across stocks and regions – stock markets outside the Americas are lower CAPE Ratios and higher expected returns. And remember, timing is a trap. If there were reliable trading signals, everyone would follow them. And then there would be no one upstairs to sell to and no one downstairs to buy from.
This article appeared in the Finance & Economics section of the print edition under the heading “Time Warp”.