When a Great Economist Attempted to Time the Market – A Cautionary Tale

Wednesday, September 18, 2013 5,267 views

One of our favorite sources of investing-related videos is sensibleinvesting.tv which is operated and financed by Barnett Ravenscroft Wealth Management based in Birmingham, England. We find them to be both highly informative and entertaining as well. One of their recent videos that particularly resonated with us is How Keynes Gave up on Market Timing, which is actually a follow-up to Stock Market History: A Crash Course for Investors, Part 4. Please take ten minutes to watch both of them.

We all know that John Maynard Keynes is probably the single most influential economist of the 20th century, and his ideas are widely felt in today’s economic policies. Whether or not that is a good thing we will leave for another time. Regardless of whether other economists agree or disagree with his policy prescriptions, his brilliance and mastery of his field remains uncontested.

As discussed in the video, while he was managing the endowment for King’s College, Keynes took a larger-than-normal equity exposure in 1929, just in time for the crash that started in October. Having access to reams of economic data that was simply unavailable (or undecipherable) to the general public, Keynes was better positioned than anyone to determine when was the right time to be in the market, yet he got it wrong. More details may be found in this paper by Elroy Dimson, David Chambers, and Justin Foo of the Cambridge Judge Business School.

Interestingly enough, this was not Keynes’s first misadventure in the financial markets. As detailed here, Keynes engaged in currency speculation following World War I. Based on his economic research, he went long on the US dollar and short on the European currencies. While this was a good bet for the long-term, the short-term gyrations caused him to lose his bankroll which was heavily margined. This led him to one of our all-time favorite quotes of his:

“The market can stay irrational longer than you can stay solvent.”

To summarize, we agree wholeheartedly with the conclusion drawn by the narrator of the two videos, Robin Powell.

“So if not even Keynes could time the market, it stands to reason that for the amateur investor, it’s all but impossible. We should also treat with skepticism the claims of so-called experts that they have the knowledge and skill to get in and out of the market at just the right time.”

Indeed, IFA has marshaled a group of studies in Step 4: Time Pickers drawing this exact conclusion. As Professor Elroy Dimson reminds us, time in the market rather than timing the market is what matters. As one of the authors of the Credit Suisse Global Investment Returns Yearbook which tracks the equity market returns of 20 countries since 1900, Dimson is in an unassailable position to declare the futility of market timing. Indeed, he and the other authors of that book tested a market-timing strategy of buying equities when dividend yields were higher than the historical average and selling them when they were lower. In all 20 countries, they found that the simple buy-and-hold strategy outperformed the market-timing strategy that attempted to buy low and sell high.

Returning to Keynes, Dimson found that he learned a lesson from his failed attempt at market-timing, and he went on to manage the endowment in “bottom up” and “buy and hold” approach and did quite well in the following decades which saw the Great Depression and World War II. Unfortunately, not all investors learn the appropriate lessons from their failures, and they continue their attempts at time picking (or stock picking or manager picking) until they have done irreparable damage to their wealth.

If you have any questions or concerns about market-timing, please feel free to drop us a line at [email protected]


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