Timing the Markets?

When the stock market moves lower for a period of weeks, as happens almost every year, is it a good time to initiate new positions? Or is it better to sit on the sidelines or even decrease market exposure until the turmoil subsides? In more general terms, can we predict stock market bottoms or tops? Can we predict tops or bottoms for individual stocks?

We are not convinced that any system or indicator can consistently predict market tops or bottoms. Past experience suggests that we personally have no ability to predict the direction of the stock market over the next week, the next month, or the next year. However, it is possible to determine that the overall market is at elevated or depressed levels relative to historical norms. Similarly, an individual stock sometimes is obviously valued more richly or more cheaply than its peers or its own historical averages. Is this information about relative valuations useful in determining whether to increase or decrease market exposure? Clearly at extreme valuations, such as the Dot Com bubble peak in 2000 and the Great Recession bottom in 2009, assuming a reversion to mean valuations is a good strategy. But what about the more typical situation, where the market or a stock is “sort of expensive” or “sort of cheap”? Do we use this information in our investment decisions, ignore it favor of some version of a “dollar cost averaging” plan, or have no timing strategy whatsoever?

     Timing the overall market

 We could devise some type of semi-quantitative rule to time investing new money in the stock market. For example, only invest new money when the S & P 500 P/E is at least 10% below its historical average (an average P/E is approximately 15) and only sell stocks when the S & P 500 P/E is at least 10% above its long-term average.

Relative to expectations, the market usually lingers in overvalued or undervalued territory longer than expected. For example, the post-recession advance seemed to reach overvalued territory by 2013, but cutting back at that point would have meant missing years’ worth of gains. One possibility is to buy on corrections unless a recession accompanies the stock market decline. However, this may mean that we have bought stocks too early and are forced to sit through further declines before the market turns up again.

     Timing for individual stocks

 How to time buying for individual stocks also is a difficult question. As value investors, we like to buy undervalued stocks. However, “undervalued” usually means out of favor with Wall Street, and a stock can remain out of favor for a long time. Nonetheless, we generally try to buy stocks when they are temporarily oversold. Probably a more prudent strategy is to wait until the stock has bottomed and started to move back up before buying it. You will not catch the bottom in the stock, but you also will not ride it down another 20% if your bottom fishing is ill timed.

Every market technician seems to have his or her own favorite indicators that identify optimal times to purchase stocks. We have found that the Relative Strength Index (RSI) is somewhat useful in identifying short-term bottoms in some, but not all, stocks. RSI is less useful in identifying tops in stocks as it can persist in overbought territory for a significant period of time.