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The perils of market timing

Tom Stevenson

Tom Stevenson - Investment Director

The thinly-traded markets of the Christmas holiday period can be a perilous time in the market. A combination of investment funds rebalancing their assets ahead of the New Year and people on holiday can exaggerate market movements.

That certainly seems to have been the case in New York this week (where they don’t let Boxing Day get in the way of making money). Monday was one of the worst Christmas Eves ever for investors; Wednesday was the best day in the market since 2009.

The S&P 500 index of leading US shares bounced back by 5% yesterday which is remarkable enough by itself. When you consider that some giant shares like Amazon were up by nearly 10%, it was clearly a pretty extraordinary day in the market.

Other volatile assets, like oil, were also strong yesterday. The widely-traded Brent crude contract rose by nearly 9%.

It is worth putting these moves in context. The S&P 500 is still more than 10% lower than at the start of December. It has still been a shockingly poor month. Oil, too, peaked at $86 a barrel so the current price in the mid $50s still represents a major fall.

But the dramatic rally in prices on Boxing Day is a timely reminder of the dangers of trying to time market moves and of the need to remain calm in the face of volatility.

It is remarkable how often the very worst days in the market are followed almost immediately by some of the strongest rallies. Stock markets are like pendulums; they swing too far in one direction and then inevitably swing hard back again.

Investors who lose their nerve during the big falls, and sell their holdings, risk committing a double error. They get a poor price for their investments and then fail to benefit from the upturn that follows hard on the heels of the correction.

You might think that this would be relatively unimportant but you would be wrong. Here at Fidelity we have studied the impact of missing out on even a handful of the best days in the market and concluded that it can be extremely damaging to your long-term financial health.

Most recently, we looked at the performance of the world’s main markets between 1992 and the end of September this year.

We found that an investor who had remained fully invested in the FTSE 100 index throughout that period would have enjoyed a total return (including reinvested dividends) of 559%. However, missing just the best five days in the market during that period would have reduced the total return to 343%. And missing the best 30 days would have left this panicky investor with just a 48% return.

The reason is simple. Missing the big rally itself is not the problem. Rather it is the fact that all subsequent daily movements are applied to a lower starting amount.

The story is the same wherever you look in the world. A 1,017% return for an investor in the US market over the same period would have been reduced to 641% without the five best days in the market and to 129% if the 30 best days had been skipped.

In Japan (where the market has performed relatively poorly over that period) a 43% total return would have become a total loss of 9% and 78% respectively for an investor who sat out those strong days.

Clearly, this analysis depends on the fact that markets generally rise over time. The arithmetic naturally works in both directions and missing the worst days in the market would obviously help your overall returns.

But the point here is that timing these good and bad days is impossible. In fact, it is worse than impossible because, human nature being what it is, you are extremely likely to be out of the market during the big rallies as these tend to come when the outlook is worst.

So, while we suggest having a small amount of cash in a portfolio can make sense during periods of volatility - helping you take advantage of dramatic swings in sentiment - it is easy to be too cautious as an investor.

Stock markets have been described as the Triumph of the Optimists. Taking a long-term view and remaining invested through the inevitable ups and downs of the market is the best approach.

Five year performance

(%)
as at 24th Dec

2013-2014

2014-2015

2015-2016

2016-2017

2017-2018

FTSE 100

2.2

-1.8

17.6

11.7

-8.2

S&P 500

21.3

4.6

36.0

10.2

-6.7

Nikkei 225

2.4

9.7

28.6

12.4

-5.3

Past performance is not a reliable indicator of future returns

Source: Thomson Reuters Datastream, as at 26.12.18, in local currency with dividends reinvested

Important information

The value of investments and the income from them can go down as well as up, so you may get back less than you invest. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.