The Dangers of Market Timing

Investor John Hussman runs the Hussman Strategic Growth fund and is bearish on stocks and has been for a long time. With the S&P 500 up near all time highs, his pessimism continues. Last year, he wrote that he believes that it is plausible to expect the S&P 500 to lose 40-55% of its value from its peak.

It is true that market valuation is high and I, along with many other investors, believe that there will be a correction sooner rather than later (although I would expect something much smaller than the 50% correction Hussman is looking for). I have a current target of 15% cash for client portfolios for that reason, so we can take advantage of better values when there is a correction. But the reason that hedge is small is because I also understand that the market will behave irrationally, and I don’t want to carry large percentages of cash, or more aggressive hedges, in the hopes of catching the market right when it falls.

Valuations are high, but markets may not correct for long periods of time, and responding to high valuations aggressively can put an investor in a hole that is difficult to dig out of.

This is the hole that Hussman has put himself into. Hussman has been so sure that the market is overvalued and about to correct itself that he has had a large short position in his fund for years. As the market has risen, his fund sunk. Of course, there is an irony here. As he was trying to time a market crash, his fund has itself crashed more than 40%.

There is such a large gap between market returns and Hussman’s, that even when the market does correct, he may not come out ahead. He needs to beat the market by more than 100 percentage points to break even for the decade. Hussman took an aggressive approach to timing the market, and was confounded by irrational market behavior. That illustrates why even smart investors can’t outthink the market in the short-term.

When investors try to avoid the risk of temporary downturns in the market, they hurt their overall returns. Together, inflation, real growth, and retained earnings give stock markets a significant upward bias over the long-term. That means missing rallies can be more harmful than falling during a downturn. Or to look at it another way, the market will return about 8% over the long-term and all the short-term gyrations are noise. Investors that beat the market pick superior stocks and wait for fair valuation; they don’t try to outguess the market’s next move.

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