A time to reap, a time to sow
A time to sail, a time to row
At the top, it’s time to go
Where it is, no one knows
A friend of mine lived on water and owned a small sailing dinghy. When the breeze picked up, you could hoist the sail, point downwind, and marvel as you glide silently across the water. Forward progress seems to take almost no effort as the wind carries you along.
Before you know it, you are at the other end of the lake, and it is time to turn back… Aw, but that’s when sailing takes on a different tone. Suddenly, the sail begins to luff and the boat's momentum fades. If you want to continue, or even avoid going backwards, it's time to pull out the oars.
Suddenly forward progress requires constant effort. What was once easy becomes difficult. Fun becomes work. The boat is dead in the water if you sit and do nothing. In fact, left to its own devices, the wind will likely push it backwards. In this way, sailing is similar to trading.
In the markets, there is also a time to sail and a time to row. The stock market oscillates between periods of overvaluation and undervaluation. Sometimes the stock market as a whole is cheap, and other times it is historically expensive.
It intuitively makes sense that to make money, we need to buy low and sell high. But how do we know when stocks are low, or when they are high? Thanks to the below chart by currentmarketvaluation.com, we can see at a glance when the market is historically overvalued vs undervalued.
Just looking at a trend can’t show us exactly when we are at a market top, but it can show us when it is time to start looking for the oars.
Look closely at the chart above. It is not a price chart of the stock market, but rather a valuation chart. It shows when the stock market is becoming cheaper, and when it is getting more expensive relative to it's long-term trend.
If we look at the previous peaks in valuation, they coincide with important market tops in price as well. The bear markets that began in ’29, ’66 and ’99 all began when the stock market was at historically high levels of valuation.
We are often told by our local broker that the key to successful investing is buy-and-hold. “Never try to time the market,” is their mantra. We have no problem with buying and holding, but WHEN you begin to buy and hold matters… A LOT.
Since the financial industry is always showing previous examples of where buying and holding resulted in great gains, we are going to show some periods of time where a buy-and-hold investor didn’t fair so well. This isn't to dissuade people from buying and holding, but to illustrate why it is important to at least partly time your buy-and-hold purchases so that they coincide with some semblance of value.
Pity the poor buy-and-hold investor that walked into a broker’s office in 1929! They would have been shown ten-year charts of how much money they would have made had they simply invested for the long-term and sat tight. And the charts weren’t lying. The best investment strategy during the 1920’s was to buy the index, and sit tight while the market trend lifted your portfolio ever higher. An investor in 1929 would look like a genius if they simply bought all the stocks in the Dow ten years earlier, and then did... nothing.
But what happens to the poor sap that tries to duplicate that result in 1929? If we fast forward ten years to see how they fared, genius isn't the word that springs to mind. Ten years later, and the market was still down roughly 65% from its peak. Let that sink in for a minute. If you began your investment career in 1929 and followed the buy-and-hold advice that is so common in the industry, you would have been rewarded for your efforts by being DOWN 65% a decade later.
Let's look at another example.
In one respect, the 30's was very different than the 70's. In the 30's, the dollar was backed by gold internationally. That meant the dollar maintained its purchasing power similar to how gold does. In other words, a 1929 dollar was about as valuable as a 1955 dollar was. When Nixon severed the gold link, the dollar was free to plunge in value, which it wasted no time in doing so against other assets, including stocks. A 1982 dollar was MUCH weaker than a 1966 dollar was, but even when measured in weaker dollars, the market failed to rise.
Once again, pity the poor investor that walks into a brokerage firm in 1966! They too, would have been shown charts of the past decade to see how much money they would have made had they simply bought stocks and then sat back and did nothing. For their efforts, they would have been rewarded with exactly zero in nominal terms, but would have actually lost a substantial amount of money in real, inflation adjusted terms.
So where are we today? Are stocks cheap or expensive? Are we about to sail downwind, or do we have to row upwind? We know from the valuation chart above that stocks have never been so expensive relative to their underlying performance. If we look at a price chart, we can see that for the most part, stocks have greatly rewarded the buy-and-hold investor for the past decade or longer. No doubt, your local broker will have plenty of ten-year performance charts to show you how well you would have done had you simply bought stocks and then did... nothing. But will buy-and-hold investors look as smart ten years from now? Is buy-and-hold the best strategy at current valuations? We can't wait to find out. Well, actually, we will have to wait to find out. Time will tell.