The following is an excerpt from Jackass Investing: Don't do it. Profit from it. It's a book that takes "conventional knowledge" on investing and argues that it's a myth.
Perhaps one of the most famous anecdotes related to market timing can be attributed to Baron Rothschild. In July 1870, Napoleon III, the nephew of Napoleon Bonaparte, threw France into a war with Prussia. The result was a disastrous for France. In September 1870 the Prussian army began the siege of Paris. After a massive bombardment of the city, on January 28, 1871, Paris surrendered and a new provisional government was formed. During the siege however, hundreds of thousands of Parisians became armed members of a citizen’s militia known as the “National Guard,” which held 400 cannons on the Butte Montmartre. The new government viewed this as a threat and ordered its own troops to seize the cannons. But instead, the government troops rebelled against the order and effectively joined forces with the National Guard. Fearfully, the govern-ment members fled to Versailles, leaving the Central Committee of the National Guard as the only effective government in Paris. In keeping with its democratic ideals, the Central Committee arranged for elections for a “Commune,” which took place on March 26th.
Soon thereafter however, government forces returned from Versailles and besieged the city. Their forces, enlarged by French POWs released by Prussia, pushed back the National Guard. The siege reached its climax during “La Semaine Sanglante,” or “The Bloody Week,” in May 1871, when as many as 30,000 people were reportedly executed or killed in fighting. It was at that time that a young man, who had just received a large inheritance, called on the great banking firm of Rothschild to ask their advice on how best to invest his fortune. Here’s a recounting of the story as published in a 1917 edition of The Gas Record:
In 1871 when the Commune in Paris was at its height and the streets were red with blood, a young man called on the great banking firm of Rothschild to ask advice about a large fortune to which he had become heir. The head of the house told him to buy French Government Securities. “What: buy securities when the streets of Paris are running with blood!” was the young man’s surprised exclamation. Baron Rothschild is re¬ported to have said: “My young friend, that is the very reason that today you can buy securities for 50% of their face value.”
This led to the oft-quoted adage “Buy when there’s blood in the street.” Investment opportunities are presented to you at exactly the time you are least emotionally prepared to accept them. That is precisely why they exist.
Fortunately, investment opportunities do not require actual blood to be spilled. Far less dramatic opportunities are pre¬sented every day. And the world’s greatest investors, in fact “The World’s Greatest Investor,” regularly employs market timing.
“The World’s Greatest Investor” (also known as The Oracle of Omaha)
“The World’s Greatest Investor” (the phrase often used when referring to Warren Buffet), is a market timer. Buffet’s company, Berkshire Hathaway, held $47 billion dollars, a full 28% of its market capitalization, in cash at the U.S. stock market peak in the fall of 2007. This was the most cash ever held by Berkshire Hathaway and turned out to have been a great time to have been in cash, as stock prices fell by more than 50% over the ensuing 18 months. Rather than increasing his stock positions at unattractive prices he engaged in market timing by making the decision to hold a large cash position.
Conversely, as stocks began to collapse during the financial crisis of 2008, Buffet began to buy. First he picked up a distressed position in both Goldman Sachs and General Electric. In late 2009 he capped off his buying spree with a purchase of the remaining shares in Burlington Northern Santa Fe railroad that he didn’t already own. At a price of $44 billion, this was, by far, the largest purchase Buffet’s company had ever made.
Buffet knows and uses what you learned in Myth #1 – Stocks Provide an Intrinsic Return – short-term stock prices are driven primarily by people following their emotional weather vane. When they are depressed about corporate prospects, as they were during the 2008 financial crisis, they drive the prices of stocks straight down.
Warren Buffet is a “value investor” only because people, through their knee-jerk buying and selling patterns, consistently provide him with the perfect opportunity to be one.
Perversely, the recognition of this short-term behavior leads to Buffet’s reputation as a long-term investor. Once he’s made his opportunistic purchase, Buffet holds many of his stock posi-tions for long periods of time. He is capturing the benefit of corporate growth, which dominates stock prices over long periods of time. He is hand-picking individual stocks. Not the market. He is interested in reaping the benefits of selecting strong, well-managed companies and being rewarded in higher stock prices for their individual corporate performance.
Stocks aren’t the only financial instrument Warren Buffet market times. As Mr. Buffet succinctly describes in his 2007 letter to shareholders of Berkshire,
The U.S. dollar weakened further in 2007 against major currencies, and it’s no mystery why: Americans are a lot more excited about buying products made elsewhere than the rest of the world is about buying products made in the U.S. Inevitably, that causes America to ship about $2 billion of IOUs and assets daily to the rest of the world. And over time, that puts pressure on the dollar.
And a few paragraphs later he describes a long position he entered into in the Brazilian currency, the “real,” as a way to time the direction of the U.S. dollar:
At Berkshire we held only one direct currency position during 2007. That was in – hold your breath – the Brazilian real. Not long ago, swapping dollars for reals would have been unthinkable. After all, during the past century five versions of Brazilian currency have, in effect, turned into confetti. As has been true in many countries whose currencies have periodi¬cally withered and died, wealthy Brazilians sometimes stashed large sums in the U.S. to preserve their wealth. But any Brazilian who followed this apparently prudent course would have lost half his net worth over the past five years. Here’s the year-by-year record (indexed) of the real versus the dollar from the end of 2002 to year-end 2007: 100; 122; 133; 152; 166; 199. Every year the real went up and the dollar fell. Moreover, during much of this period the Brazilian govern¬ment was actually holding down the value of the real and supporting our currency by buying dollars in the market.
Not only does Mr. Buffet reveal that he is a market timer, but that he is timing a currency which as a market has proven to be the antithesis of buy-and-hold. As he acknowledges, “during the past century five versions of Brazilian currency have, in effect, turned into confetti.” As discussed in Myth #1 – Stocks Provide an Intrinsic Return, and clearly understood by Mr. Buffet, the past performance of a market is virtually irrelevant when considering whether to buy or sell it today. All that mat-ters is whether the return drivers for that market today warrant a buy or sell decision.
“Sure,” you say. “It’s easy for The World’s Greatest Investor to successfully time the market. That’s why he’s The World’s Greatest Investor. But what about me?” The answer is: you can – precisely because most people can’t.
It appears that people are hard-wired for investment failure. Because of that it is easier for financial professionals to instruct their clients to buy-and-hold rather than attempt to time the market, simply because most people will time the market incorrectly. But you don’t have to be one of those people. You can exploit their behavior.
Fantastic post! It has been my experience that the "buy & hold" mantra is shoved down retail investors' throats because it a nice, clean pitch that financial institutions can teach to an army of sales people requiring very little actual portfolio management skill in order to implement. In contrast, institutional and wealthy investors use a variety of tactics and strategies to protect their capital as they grow it. This style of investing shouldn't only be reserved for the 1%. The key, as was aptly pointed out in the post, is that one must have a disciplined sell & buy process in place to avoid the pitfalls of investing by gut-feeling or getting sucked into the herd mentality.
Posted by: Elliott | April 30, 2012 at 04:48 PM
I keep getting the late-night-infomercial vibe from these book excerpts. Anyone else?
I think the author has come up with a great premise and the cleverly manipulated examples to sell it (see the exclusion of dividends in the last excerpt). And then you too can buy real estate with no money down and earn thousands of dollars per day from the comfort of your own home! You just need to follow our patented secret method!
The comments about the book on Amazon are very enlightening. I find that authors who respond (or have people associated with them respond) to reviews of their book are trying to hide more than is immediately apparent.
Posted by: Adam | April 30, 2012 at 09:28 PM
I agree thoroughly that "buy and hold" is good for the managers of funds but is far from being the most profitable approach for experienced investors that have access to a very large database of fund data, a variety of analytical tools, and have learned how to use them to choose what to buy and when it's time to buy them.
Unless you are using hindsight, picking the absolute low point of anything is just as impossible as picking the absolute high point of any fund, stock, or bond. The technique that I have used successfully since retiring in 1992 is patterned after one that has been promoted by William O'Neil the editor of Investor's Business Daily. His method is called CANSLIM and is designed for individual stocks. I tried stocks for a while but soon switched to funds in order to obtain greater diversification I simplified his method considerably so that it was applicable to a fund which is a diversified collection of stocks or bonds. William O'Neil does not believe in "Buy Low, Sell High". Rather he believes in "Buy High, Sell Higher". Thus you conduct your search for funds that have taken a hit, then leveled off for some time, and have later broken out to the upside. You then hold them as long as their uptrend continues but sell them when the uptrend has deteriorated and that you are convinced that the uptrend is over for a while. There are a variety of technical parameters that can be easily calculated with the right software and used in arriving at one's decisions. If you find yourself in a situation where nothing that you are examining is a Buy then you are automatically out of the market. As things improve and you start finding funds that have acceptable uptrends you start buying and if the trends continue it's not long before you are fully invested again. Sometimes you even sell a fund that is trending up nicely and replace it with one that is in a steeper uptrend. With this technique not every fund you buy will be a winner but you will have a high success ratio. More importantly you will never be trapped into holding your funds as they go down lower and lower and losing half of your assets as recently happened in the 16 months between 11/1/07 and 3/1/09.
Wouldn't it have been better to start taking profits a short time after 11/1/07, staying out until things start improving, and then starting to buy back in again a short time after 3/1/09? However you need to have the time, the data, the tools, and the experience in order to do it. There's no magic bullet.
Posted by: Old Limey | April 30, 2012 at 09:30 PM
The idea that "you can't time the market" is one of the biggest myths out there that seems like is universally accepted as truth. You absolutely can time the market, the only trick is, you had better be pretty smart and pretty risk tolerant to do it. But if you can do it, you can easily exceed the returns of a simple buy and hold strategy. After all, the entire growth in value of the US equity market can be attributed to a single 18 year period of growth. That really tells you all you need to know right there.
Posted by: Bad_Brad | April 30, 2012 at 09:56 PM
You can't time the market in the sense that you can't guess which specific day it's going to be at its highest or lowest. You can't guess which hour or minute is the very best time to buy or sell.
But you can recognize when the market is offering an irrationally good deal (either buying or selling) and take advantage. You can recognize pretty good times to buy or sell. Somebody else might get an even better deal than you from time to time, but that's OK; all you need to do is consistently get pretty good deals and you'll be way ahead of others.
Posted by: LotharBot | May 01, 2012 at 01:59 AM
Adam --
This whole book is written in that style, I believe on purpose (but maybe not.) It has the whole contrarian vibe going that also hints of infomercial.
Posted by: FMF | May 01, 2012 at 07:38 AM
@LotharBot
>But you can recognize when the market is offering an
>irrationally good deal (either buying or selling)
It is easy to recognize AFTER the fact. But not so much while it is happening. Why wouldn’t large funds eliminate all of the market irrationally buying up bargains at the slightest drop and taking profits whenever the price was too high? I’m sure they try to do that- and fail as we have more volatility than ever.
The fundamental problem is that it is VERY hard to assign a fair value to a stock- because we don't know the future. Is apple (AAPL) priced fairly today at 591.66? If so did you buy it when it was half that price a year ago? If you think it is overvalued, are you sure enough to risk shorting it?
-Rick Francis
Posted by: Rick Francis | May 01, 2012 at 12:53 PM
@Rick Francis:
> *"It is easy to recognize AFTER the fact."*
You may not have the data to be able to tell if AAPL is fairly priced; I sure don't. But I did have the data to recognize a housing bubble in 2007, and I did have the data to recognize stocks were on a once-in-a-generation bargain price in March of 2009. A month ago I found a house that was worth paying cash for.
If you get the "big things" right -- recognizing big bubbles and panic selloffs -- you can get way ahead. Even if you only recognize them once in a while, and only put a portion of your net worth "at risk", you can get fantastic returns. You don't need to take risks on individual stocks or make moves every day, just wait for enough investors to do something dumb with a particular asset class and then do the opposite.
Posted by: LotharBot | May 01, 2012 at 02:11 PM