Why It's So Dangerous to Time the Market

Investor John Hussman is a smart guy. He seems nice. This is nothing personal.

But Hussman is bearish on stocks. He has been for a while. With the S&P 500 up more than 20% this year, he sounds about as pessimistic as he ever has, leading to a big front-page story in Business Insider last weekend. Hussman recently wrote:

I continue to believe that it is plausible to expect the S&P 500 to lose 40-55% of its value over the completion of the present cycle, and suspect that whatever further gains the market enjoys from this point will be surrendered in the first few complacent weeks following the market's peak.

I won't argue with this. Stocks have done well. You could call them pricey. There will be more crashes.

But Hussman has been so sure of his outlook that he's had a substantial "short" position in his flagship fund for years. As the market surged, his returns have been decimated.

The irony is that in the process of preparing for the possibility of a 40% crash, Hussman's fund has almost suffered an actual 40% crash:

Source: S&P Capital IQ. Includes dividend payouts.

This is the financial equivalent of burning your house down to avoid any chance of it being damaged in a wildfire.

The gap between S&P 500 returns and Hussman's returns is now so deep that even if his crash predictions come true, it's not at all clear that he'd win. Hussman needs to beat the S&P by more than 100 percentage points just to break even against the index over the last decade. That is a massive hurdle. I don't know if it's ever been done before. (To be fair, Hussman's returns since data collection began in November, 2000 have trailed the S&P 500 by a smaller amount, eight percentage points, according to S&P Capital IQ).

What do we learn from this? Two things.

One, there are two types of risk. The first is what author William Bernstein calls "shallow risk," or a temporary fall in an asset's market price. Stocks fall, maybe by a lot, but recover in a few years and life goes on. The other is "deep risk," or a permanent loss that's nearly impossible to recover from. I think there's a growing chance people like Hussman tried to avoid shallow risk, and in the process are now facing deep risk. Because of inflation, real growth and retained earnings, the market has a clear upward bias over the long run, and so missing rallies can be more harmful than getting caught in downturns. Put another way, avoiding a 40% crash leaves you worse off if it also causes you to miss a 170% rally. 

Two, there's an old saying in finance: "Do you want to be right, or do you want to make money?" If you're in the punditry business all that matters is "being right." Successfully managing money is different. Rather than attempting to avoid risk, I've come to believe it's far more efficient to accept it, taking the market ups and downs as they come. This means you forgo the glory of getting big calls right, but it increase your chances of making money in the long run.

I wish everyone the best, including Hussman and his investors. Maybe he'll prevail in the end. But remember what President Eisenhower said: "Pessimism never won any battle."

Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics. 


Read/Post Comments (34) | Recommend This Article (72)

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  • Report this Comment On November 12, 2013, at 4:02 PM, Mathman6577 wrote:

    Good article. It's better to be optimistic -- over the long term stocks (and the market) generally go up).

  • Report this Comment On November 12, 2013, at 4:57 PM, krohleder wrote:

    I have to respectfully disagree with this article. If an investor does not look at the big picture of market trends and fluctuations, that investor is just going to lose money. Even a good value, high growth, cash flow positive company, with let's say a p/e ratio of 10 can go down to a p/e ratio of 5 in a very short period of time. Markets can be predicted to a small degree; small enough to force an investor, as a rule, to pay attention.

  • Report this Comment On November 12, 2013, at 4:59 PM, TMFHousel wrote:

    <<Markets can be predicted to a small degree; small enough to force an investor, as a rule, to pay attention.>>

    I won't disagree with that. The problem is that most people who try get the predictions wrong -- shorting stocks for four years as the market doubles.

  • Report this Comment On November 12, 2013, at 6:27 PM, krohleder wrote:

    "shorting stocks for four years as the market doubles."

    Good point, I do agree with that there is a risk of over predicting and missing opportunities. You can lose out just as much, if not more, by missing a rally.

    It needs to be a balance and disciplined approach. For example if the S&P crosses under it's 200 day moving average, you might want to have a little higher cash ratio than you normally would. The S&P 500 has been oscillating up and down all year; so just by buying in the dips instead of jumping in at the peaks you could increase your profits even more. I did that all year and beat the market by quite a bit.

  • Report this Comment On November 12, 2013, at 11:27 PM, MartyTheCanuck wrote:

    krohleder : good for you if you're beating the market with timing. You're in the minority though. It is not easy. Most people get the timing wrong and lose a lot of opportunity.

    I'd rather be invested, with a moderate amount of cash in case of better opportunities. And I beat the market with stockpicking, not timing.

    Morgan, I'll have to disagree with your punditry argument. Many pundits, in politics, sports or finance have been wrong for a long time and still have job. You just have to "sound" right, to a specific audience to be a pundit.

  • Report this Comment On November 12, 2013, at 11:55 PM, Intrepidation wrote:

    "The pessimist complains about the wind, the optimist expects it to change; the realist adjusts the sails" -William Arthur Ward

  • Report this Comment On November 13, 2013, at 2:25 AM, villanue wrote:

    Assuming realist has a good grasp of the intricacies of sail adjustment. Otherwise, the realist becomes a pessimist because he is worse off than had he just left the sail alone:-)

  • Report this Comment On November 13, 2013, at 5:20 AM, TMFHousel wrote:

    Marty, that's fair. I'd add that for most pundits the goal is to get the big calls right, but no one holds you accountable on timing, so you get a lot of broken-clock-is-right-twice-a-day people.

    -Morgan

  • Report this Comment On November 13, 2013, at 10:36 AM, TMFTheDude wrote:

    Great column, Morgan.

  • Report this Comment On November 13, 2013, at 11:52 AM, Archaeologist77 wrote:

    Thanks for the insight Morgan - another one of those areas where I have lots of questions about investing as a 3rd year "rookie" investor. Two questions:

    1) Is "timing the market" a specialized use of the phrase in the context of equities?

    If we follow any premium TMF services like Stock Advisor or Rule Breakers there is the obvious "Buy Now" recommendation each month, which I assume is "timing the business" not "timing the market."

    2) How does "timing the market" differ from when we buy stocks based on TMF recs?

    Often, my investment in TMF recs are delayed by one month through the process of transferring funds to my account, but I assume neither is this timing or failing to time the market. Correct?

    Thanks.

  • Report this Comment On November 13, 2013, at 2:28 PM, bamasaba wrote:

    And unfortunately, when a crash does come (which will happen eventually with absolute certainty) the pundits will start talking about how smart people like Hussman are because they 'predicted' it.

  • Report this Comment On November 13, 2013, at 5:09 PM, wavesfan wrote:

    Hussman is less about crash prediction and more about pushing the chips to the center of the table when the odds are in your favor. This is how investors should think.

    "avoiding a 40% crash leaves you worse off if it also causes you to miss a 170% rally" True, but barely. Although you'll probably sleep well at night avoiding the crash. The math is simple: $100 invested followed by a 40% market crash leaves you with $60. A 170% rally gets you back to $102. Most people would give up the $2 gain to avoid the crash to $60.

    It's all about peak to peak or trough to trough (full market cycle) returns. Hussman will probably be proven right because he has a process and data that backs up his thesis. I imagine he would be offended by the "pundit" label.

  • Report this Comment On November 13, 2013, at 6:49 PM, TMFHousel wrote:

    Thanks for the comments, wavesfan, but I don't think your math is quite right. A 170% rally from $60 brings you to $162, not $102.

    Regarding Hussman being about pushing in the chips when the odds are in your favor, why did he return a large chunk of money to investors in 2008, when stocks were the cheapest they had been in decades? (Serious question, there might be a good answer).

    Regarding a full market cycle, Hussman's fund started in 2000, near the peak of the dot-com boom. If we're currently at a peak, then we've experienced a peak-to-peak cycle. His fund has underperformed an index fund over this period.

    << I imagine he would be offended by the "pundit" label.>>

    Anyone who would be offended by being called a pundit should not write a frequent, several thousand word, high-profile investment letter open for anyone to read.

    Thanks for reading,

    Morgan

  • Report this Comment On November 13, 2013, at 6:55 PM, TMFHousel wrote:

    Also, the definiton of pundit is "an expert in a particular subject or field who is frequently called on to give opinions about it to the public." I don't consider it an insult in any way. It's just a very different field than successfully managing money because there is no visible score card.

  • Report this Comment On November 13, 2013, at 7:17 PM, duuude1 wrote:

    "avoiding a 40% crash leaves you worse off if it also causes you to miss a 170% rally"

    True - hugely true.

    I've invested for over 2 decades now, meaning through both the 2001 dot-com crash, the 2008-9 housing/credit crisis, and a total of three recessions.

    During it all, I threw an increasing amount of every single paycheck into stock indexes (and then into both indexes and individual stocks) without fail. And I never cashed out to "protect" my gains. Otherwise I'd have exactly the same problem Hussman is having - when do you get back in? If you get out because of fear, you'll stay out because of fear.

    So I agree with you wholeheartedly that the upsides of a continuous investing approach are huge.

    I'm with ya duuude!

    Duuude1

  • Report this Comment On November 13, 2013, at 7:44 PM, colleran wrote:

    You know, Morgan, no matter how many times you make the case against market timing, and this is a good one, some people just can't help themselves. I learned that lesson the hard way. Keep informing us about this. Maybe more people will actually start listening, although I have my doubts.

  • Report this Comment On November 13, 2013, at 8:40 PM, NickD wrote:

    you don't have to worry about market crashes when you own KO stock....

  • Report this Comment On November 13, 2013, at 8:47 PM, wavesfan wrote:

    Morgan,

    Thanks for correcting my math and being civil about it. I goofed.

    Having said that, I still believe Dr. Hussman makes a very strong argument in favor of being cautious now and his record speaks for itself.

    You state: "Regarding a full market cycle, Hussman's fund started in 2000, near the peak of the dot-com boom. If we're currently at a peak, then we've experienced a peak-to-peak cycle. His fund has underperformed an index fund over this period." Not true. HSGFX is up 72% from 07/24/2000 (inception) to today. VFINX (S&P 500 proxy) is up 55% over the same period.

    The first peak to peak cycle for his fund was actually from inception on 07/24/2000 to market peak on 10/09/2007. HSGFX was up 120% vs. 20% for VFINX. The most recent peak to peak, 10/09/07 to today, admittedly, hasn't been as strong (-21% vs +29%) but protecting on the downside has led to outperformance over the entire period.

    Regardless, my main point is that avoiding a good portion of major declines gets most investors a long way towards decent returns over the long term, even if you miss a decent chunk of the upside. Correct my math if I'm wrong but doesn't a 50% decline require a 100% return just to get back to even? The same number for a 20% decline is only 25%.

    Remind me about Hussman returning money to investors in 2008? (Serious question, I wasn't a shareholder then). That year ended with stocks cheap but spent the first 9 months with CAPE10 above 20 (most expensive quartile of the last 125 years) and market cap / GDP above 85 (also most expensive quartile historically)

    I like the article a lot, by the way. Thanks getting the discussion going.

  • Report this Comment On November 14, 2013, at 1:02 AM, jimmymason wrote:

    Yes, one thing we do know is the long term trend of the stock market is up. It has continued in an upward trajectory since it's inception. I think one of the reasons Warren Buffett has done so well is that he always stays in ! Over long periods of time this is definitely the winning strategy.

  • Report this Comment On November 14, 2013, at 3:27 AM, CraigWPowell wrote:

    Hussman Strategic Growth fund performance in the long run is -40%.

    Apple the second in the holding list was down -20% in 2013. AAPL is on holding list of many mutual funds as well.

    Year to date through the end of September 75% of mutual funds have underperformed the S&P 500, this one: //iknowfirst /sample-portfolio-return-1-month

    was different with +46.27% return 01/13-10/13 versus S&P500 +24.23% return in the period

  • Report this Comment On November 14, 2013, at 3:59 AM, AnsgarJohn wrote:

    Noreena Hertz: "Overcome your maths anxiety."

    see her new book: Eyes Wide Open: How to make smart decisions in a confusing world.

    Don't buy stocks willy nilly "because they always go up in the long run"

  • Report this Comment On November 14, 2013, at 6:50 AM, TMFHousel wrote:

    Thanks, wavesfan. S&P Capital IQ (my data source) keeps data on HSG starting in November 2000. From that date, the fund has underperofrmed the S&P -- that's where my claim came from.

  • Report this Comment On November 14, 2013, at 7:57 AM, ravenesque wrote:
  • Report this Comment On November 14, 2013, at 8:38 AM, pondee619 wrote:

    I have a question:

    A while back I bought TSLA @ about $35.00. When it jumped to circa $100.00 I sold 1/3 of my holdings. When it got to circa $160.00 I sold another 1/3 or my original holdings. I now own 1/3 of my original TSLA holdings at a substancial negative cost. No matter what happens to the stock from hereon out, I can't lose, I'm profitable. After the dust settles, I may, or may not, limp back into a more substancial position.

    Am I timing the market with TSLA by doing this? Is this, then, wrong?

    Thanks:

  • Report this Comment On November 14, 2013, at 8:41 AM, giovannidiimauro wrote:

    Hi Morgan,

    I am breaking into stock writing. Can you tell me how i can write article for the fool? i have a timely piece right now that i would like to Publish. I have an article on Seeking alpha, and want to contribute to the fool, but do not see it on the website. any help would be greatly appreciated

  • Report this Comment On November 14, 2013, at 8:51 AM, KombatKarl wrote:

    wavesfan, there's nothing fundamentally wrong with what you are saying. The loophole is, as the article is trying to say, you can't time when the crash will start and end. Of course it would be best to have gotten out in September 2007, and gotten back in in March 2009, but who knew? Hindsight is always 20/20. How do you know if we're in a major decline or just a correction? If it turns out to be a decline, how do you know how long it will last? "Experts" were still calling for a double-dip well into 2011. But here we are still going up.

  • Report this Comment On November 14, 2013, at 10:52 AM, SkepikI wrote:

    Morgan: I liked and appreciated the example. I am not so taken with the article. BUT maybe you can follow it up with something more useful, like "How to discipline yourself to avoid this classic mistake" or better- why it looks so attractive to try to time the market - when your example turns out to be correct in a year or two or ten....

    The psychology (no I am strictly an observer, not a professional) of timing the market when its on a tear is compelling. So compelling that most inexperienced (not burned) investors have to try it at least once, yes me included. When they get burned, if they are good observers only once, if not multiple times, they come right up against your observations, painfully I might add, but not necessarily what to do about it. AND what works for you might not work for me, or the guy behind the tree....

    USEFUL strategies for avoiding the compelling timing fairy are fodder for a much better article. Mine turned out to be rigid allocation approaches and zealous re-balancing. Saved me quite a lot in a couple of nasty corrections, and one crash.

    I will however disagree with you on one thing, and that is when timing is actually a very good strategy. That is when you are approaching your goal or have exceeded it and you are out of time or will be soon. Catching the market in a climb, like this one and getting the timing right when you recognize you made your minimum nut, or critical mass or whatever you call it, is a timing call I hope you and every other fool out there gets to experience. And don't blow it because some fool (ha) told you timing is bad ; -)

  • Report this Comment On November 16, 2013, at 3:23 AM, observerbob2013 wrote:

    I have been investing with some success for more than 50 years and I always find articles like this one rather annoying.

    To suggest that timing is not important is truely foolish. Timing your investment is just as important as picking the right stock but relying totally on timing market trends or on picking alone is a recipe for disaster.

    Personally I believe that shorting is the most dangerous form of investing. If you are right it can be very good but if you are wrong the loss can be spectacular. In options it is possible to limit loss but in shorting limitation is problematic., If you are badly wrong there may be no market for your stop-loss as the existance of the 'short-squeeze' is no urban myth.

    If you pick a good stock on fundamentals and the market doesn't agree with you, so long as your knowledge of the fumdamentals was correct, you will suffer some short term illiquidity but in the long term you will normally recover at least something.

    However the golden rule of investing from my point of view is spreading your risk. Betting the house on Apple or Tesla may result in a mansion or a shack because the risk/reward ratio in each is very high. It is far more sensible in my view to have a good spread over 10 or more stocks and learn how each trades from day to day so that part of your capital is used to take advantage of short term movements and some in the pursuit of the retirement bonanza.

    The bottom line, however, is that you must understand what type of investor you are. Are you active or passive, can you truely analyse amd understand stocks, or do you relly on others. In the end investing is like any other business you only succeed on your own if you treat it as a serious business and are prepared to put time and effort into it.

    Listen to everyone BUT MAKE YOUR OWN DECISIONS

  • Report this Comment On November 16, 2013, at 12:33 PM, erkaye wrote:

    Morgan,

    Hussman has not been a great investment, but your analysis is fundamentally flawed...Though I totally agree with your thesis.

    I've had the Hussman fund since 2001 and have, despite the chart you are showing, made money on it. Perhaps the difference is that the chart you provided does not reinvest the substantial dividends and capital gains distributions they are required to pay every year.

    This is a common problem trying to use stock type charts to value mutual funds. The actual return is about 4%/year since I bought. The past five years have been brutal however with a loss around 5%/year. Not what I signed up for.

    That said, I am in the process of exiting my Hussman position. I have made far more in my personal trading account, thanks to MF and other sources of advice and entertainment.

    Thanks for the 3D printing shootout you guys!!

  • Report this Comment On November 16, 2013, at 4:35 PM, TMFHousel wrote:

    <<Perhaps the difference is that the chart you provided does not reinvest the substantial dividends and capital gains distributions they are required to pay every year.>>

    As the chart notes, dividends are included.

  • Report this Comment On November 16, 2013, at 4:36 PM, TMFHousel wrote:

    I would say the discrepancy is due to my starting date not matching up with yours.

  • Report this Comment On November 16, 2013, at 5:29 PM, 092326 wrote:

    I generally concur with your conclusion. However, their are times when it would appear wiser to sit on cash or cash equivalents after a long rise in stock prices, and I think this is one of those times. Also, on a long term basis our country is becoming more and more of any entitlement society which will eventually lead to a a socialist or semi-socialistic nation. This would appear to more inevitable with the have-nots in society beginning to out vote the haves. As an example I quote the statistics of NYC where it is has been stated that 45% of its population lives either at or slightly above the poverty level.

  • Report this Comment On November 16, 2013, at 9:46 PM, boriswart wrote:

    I don't understand shorting as a means of risk avoidance. I wonder what is wrong with using the stop loss feature as a means of protection against a large downturn. This seems like a more direct method to avoid an unexpected large loss ... with no downside to a market rally.

  • Report this Comment On November 17, 2013, at 11:57 PM, Peak2Trough wrote:

    Good article, Morgan.

    I love Dr. Hussman and I read him frequently, but generally, he is my go-to example on how being smart does not necessarily lead to market outperformance, as much of Wall Street would have us believe. Despite his extensive analysis and modeling, he has been wrong (or early) for a very long time now.

    It's also a good lesson in why passive investing, with appropriate rebalancing (not timing), is the strategy most likely to find the investor on or near the efficient frontier when the chips are counted at the end. I presume that's a point you and I (and the Fool in general) would differ on, but Hussman being an active manager, after all, lends evidence to the case.

    Having read your article, however, I am left with the following two questions:

    1. I've read Dr. Hussman for a while, and my recollection is not that he is short the market, but rather that he has used option collars for the last few years in an effort to hedge losses (and concurrently restrain gains).

    Perhaps I missed it, but has he stated explicitly that he is short the market? If not, a correction may be in order, as a collar is not short, it is neutral.

    2. Why do you suppose the graph you used above is not coincident with his own graph of the returns from the same fund here?

    http://www.hussmanfunds.com/pdf/hsgperf.pdf

    Yours clearly shows the fund has negative returns since the beginning of 2003, and his shows the opposite with (approximately) $14,000 growing to $17,000. Thoughts?

    Thanks for the article.

    P2T

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