Many people believe that research shows that market timing doesn’t work.

Many people believe that research shows that market timing doesn’t work.

doesn’t exist. That’s a myth.

Research shows that short-term market timing doesn’t work. This is where investors speculate when price movements will occur. It’s not hard to figure out why it doesn’t work. As critics of market timing often point out, for it to be effective, investors must make good guesses about when to lower and when to increase their stock allocations. Some people might be lucky enough to make it. But it seems highly unlikely that it will work consistently. I think Buy-and-Holders has succeeded with this.

But what about long-term market timing based on valuation? That has worked for as long as we have had records of stock prices. Wade Pfau spent 16 months working with me to research this question. He concluded: “Yes, valuation-based indexing (buy and hold mixed with value-based market timing) works in Virginia!”

Wade said he was surprised by what we found. He kept asking himself if he was missing something because he heard so many buys and holders say that timing the market doesn’t work, but looking at historical return data does. I agree that it is a strange reality.

I don’t believe that the people who developed the buy-and-hold strategy in the 1960s even thought about valuation-based market timing when they came to the conclusion that market timing doesn’t work. Index funds were not available at the time. Rating-based timing only works with index funds. For individual stocks, high CAPE levels may not mean that investors have behaved irrationally enthusiastically, but rather that the company’s prospects are very bright. So I don’t believe valuation-based market timing is foremost in people’s minds.

Value-based market timing always works.

Shiller was the first to consider valuation-based market timing. And of course he found that it always worked! As Shiller showed, if valuation affects long-term returns, the risk of investing in stocks is not stable but variable. If risk is variable, changing stock allocations in response to changes in valuation is necessary for investors who want to keep their risk profile constant over time. In a world where valuations influence long-term returns (the world we live in, according to Shiller’s research), it is logically impossible for valuation-based market timing to not work (at least on a risk-adjusted basis).

So it is not surprising that this happens. But to people who see the question in general, it’s surprising. This question became important to me when I asked a delicate question on an early retirement discussion board. The people there were using a study that claimed the safe withdrawal rate was always 4% to decide when to hand in a resignation letter to a job. I read John Bogle’s book. Common sense about mutual funds Reversion of stock prices to the mean is an ‘iron rule’ of stock investment. If so, the safe withdrawal rate cannot be the same figure at all valuation levels. So I suggested to the discussion board community that we consider valuation when calculating safe withdrawal rates.

Holy moly! The response was off the charts. Both ways! Some people thanked us for starting the most valuable discussion in the board’s history. And there were some who did not welcome the questions I raised.

Challenge the buy-and-hold dogma

At the time, I didn’t realize that I was challenging the buy-and-hold doctrine that market timing doesn’t work. People who don’t want to dream of early retirement considering their valuations insisted that I do. They argued that valuation-based market timing is as much market timing as a short-term guessing game. I had to admit they had a point. So I had to say that at least one form of market timing works.

That is a reality that, even today, 22 years later, is not widely accepted. why? I believe that acknowledging that valuation-based market timing works fundamentally changes the stock investing game. If valuation-based market timing works, people should reduce their stock allocations when prices get incredibly high. If people did that, there would be no more bull markets. This means there will be no more bear markets. This means much less economic collapse. That all seems fine to me. But obviously there are a lot of people who aren’t very attracted to that kind of change.

Anyway, it’s a big change. Until we get to a point where these issues can be discussed honestly on all investment sites, please consider whether it is possible for a world where valuations impact long-term returns and valuation-based long-term timing does not. It doesn’t work. I say it is logically impossible. If you come across any evidence that valuation-based long-term market timing is not working, we would appreciate it if you could let us know. I don’t trust you to come up with anything. If you do that, it might just make you famous. You will be the first to do so!

Rob’s bio is here.