The Challenges of Market Cycle Timing

By Jack Forehand (@practicalquant) —  

Everyone wants to follow the investing advice of market legends. After all, that level of success is typically not achieved by accident. Investors want to learn from their wisdom. They want to do what they do.

In some cases that can be a slippery slope, though, and it is important to consider the advice of market legends in the context of your own personal situation. .

Howard Marks’ new Book, Mastering the Market Cycle: Getting the Odds on Your Side, has prompted many investors to take a fresh look at where we currently are in the market cycle, and what changes, if any, that might warrant within their portfolios. In the book, Marks argues that the market has repeated similar cycles throughout history, and by knowing where we currently are in that pattern and adjusting accordingly, investors can improve their long-term returns.

The description of the book puts it this way:

We all know markets rise and fall, but when should you pull out, and when should you stay in? The answer is never black or white, but is best reached through a keen understanding of the reasons behind the rhythm of cycles. Confidence about where we are in a cycle comes when you learn the patterns of ups and downs that influence not just economics, markets and companies, but also human psychology and the investing behaviors that result.

There is no arguing with the first part of what Marks is saying. Markets clearly have followed similarly patterns historically. And some skilled investors can determine where we currently are in that process and alter their portfolios to take advantage of that. But for most investors, implementation of the type of advice presents a host of problems. The reason is that it doesn’t consider the factors unique to every investor that are essential to building a successful investment strategy, and sticking with it.

A good way to look at the challenge of following any particular piece of advice like this is to look at the steps that would be required to do it. Looking at things that way can often unearth the likely implementation issues that come with any change to an investment strategy. In this case, for an investor to adjust their portfolio to capitalize on where we are in the market cycle, they would need to answer the following questions.

1 – Where are we in the market cycle?

Marks thinks we are in the 8th inning. That sounds about right. We have had a long run here. If you are someone who believes a bull market starts at the bottom, we are in one of longest ever. If you believe a bull market starts when new highs are reached (I fall into this camp), then the bull market has been much shorter, but we still have had a big run.

As Marks has pointed out in recent interviews, though, baseball games can go extra innings and so can bull markets. If we are in the 8th inning, that doesn’t mean that we don’t have years to go before the eventual decline. As a result, this process is much harder than it appears on the surface.

2 – What do I do about it?

Ok, so we now agree we are in the 8th inning. But what actual changes to an investor’s portfolio does that imply? It is obviously different for every person, but Marks talks about figuring out what the standard risk level is for your portfolio and slowly moving it to a more defensive posture. Marks himself has utilized a similar approach for clients by staying fully invested, but reducing risk exposure.

There is an important lesson in what he is doing. Investors tend to want to make these bold “all in” or “all out” moves with their portfolios, but he is rightfully advocating the exact opposite. If you are going to try to adjust your portfolio based on the market cycle, the best approach is to make the moves slow and gradual. Timing the exact turn in the market is next to impossible and it is likely you are going to begin making changes well before the market actually turns. Even if you move gradually out of the market, it is likely to be tough to stick with the strategy when you inevitably underperform while the market keeps running. If you move out of the market entirely, it will be next to impossible.

3 – When so I change it?

The most challenging part of all of this is that the market is dynamic. So after we figure out what inning we are in and make our portfolio adjustments, we now face the issue of what to do when things change. What if we get a 10% correction? What if we get a full-on bear market? What if the market doubles from here? Changes in the market would call for going through this process again starting with #1. It would mean another judgement call about where we are in the cycle and a separate decision about what to do about it.

None of this is meant to say that the advice Marks has provided is bad advice. He is up there with Warren Buffett as one of the best at providing principles that help investors achieve success over time. For those who can figure out where we are in the cycle, can implement a slow and gradual process to update their portfolios to reflect that, and can stay the course when they are wrong for long periods of time, this can absolutely work. I just think most investors don’t fall in that camp. You can learn a lot from following legendary investors and billionaires. We have built much of our business at Validea on doing exactly that. But you also need to keep in mind that what works for them may not work for you. Trying to adjust your portfolio based on market cycles is one piece of advice I think most investors would be better off avoiding.

Photo: Copyright: alphaspirit / 123RF Stock Photo


Jack Forehand is Co-Founder and President at Validea Capital. He is also a partner at and co-authored “The Guru Investor: How to Beat the Market Using History’s Best Investment Strategies”. Jack holds the Chartered Financial Analyst designation from the CFA Institute. Follow him on Twitter at @practicalquant.