There’s a long history of market timing methods that work some of the time. Yet, the search for the holy grail strategy to get in and out of the market before every turn has been a failed endeavor. That hasn’t stopped people from searching or trying the latest and greatest method that worked twice in a row.
I’ve been reading a series of articles written by Philip Carret in 1926-27. Buffett was a big fan of his (so I did some digging). Carret would base a book on the series — The Art of Speculation — titled with the same name.
Despite the title, Carret was a value investor. He would go on to found one of the first mutual funds in 1928, ran it for the next 55 years while beating the market in the process. He also had a solid understanding of market history, market cycles, and the tendencies of its participants.
In one article, he points out why market timing methods fail eventually and how difficult forecasting can be.
Keep in mind: back in the day, there was a clear distinction between investing and speculation. People invested in bonds. All stocks were considered speculation. The lines have blurred since then.
The question immediately arises whether it is possible to make such forecasts with any degree of accuracy. In answer to this question it is not enough to cite the generalization that stocks should be bought when business is depressed and sold when business is prosperous. Economic history never repeats itself exactly. The depression of 1921 differed in many respects from that of 1914, the next depression will differ from that of 1921. Periods of prosperity are also unlike in many respects, differing both in type and in intensity.
Some disappointment may be felt by the reader at this point because no infallible rule for calling the turn on the major movements of the stock market has been suggested. A moment’s thought will show, however, that if there were any infallible mechanical method of forecasting the major swings of the stock market, there could be no major swings. If every trader knew or could discover by a half-hour’s investigation that the stock market was about to go down, there would be no buyers. There never was a time when every possible circumstance favored a rise in security prices nor, on the other hand, a time when every possible circumstance favored a bear market. The most that can be said is that the balance of factors favors an upward or a downward movement.
Speculation is no simple business. The amateur cannot take a few thousand dollars capital, fifteen minutes a day of time, treat it as a side-line and be any more successful than he would be in any other business. Indeed, speculation requires broader knowledge, closer attention, sounder judgment than the average business. Prices on the New York Stock Exchange are affected by French politics, German banking conditions, wars and rumors of wars in the Near East, the Chinese money market, the condition of the wheat crop in The Argentine, the temper of the Mexican Congress as well as by a host of domestic influences. The successful speculator must carefully weigh the effect of all these influences, set down the pros and cons are arrive at a sound conclusion as to the side on which the balance lies. When he has done all this he made only a beginning. If he concludes that the balance favors an upward movement, he must still decide which stocks he is to buy for maximum profit.
Not only must the trader make a careful analysis of the situation when he first decides that the trend of the market is definitely in a given direction. He must review his position at fairly frequent intervals. Bull markets and bear markets last long enough so that the average trader is likely to forget by the time the climax is approaching that any other sort of movement is possible. His judgment is not assisted by the general temper of business men at such a time. A bull market usually comes to grief when business is generally prosperous with few clouds on the horizon. At such a time many business men are making plans for expansion, business leaders are talking optimistically, the outlook is rosy. Under such conditions it requires real backbone to sell stocks, many of which will still appear to their owner undervalued in comparison to many of the stocks which he does not happen to own. The reverse conditions prevail when a bull market is born. Business is then depressed, failures are numerous, business is apparently going to the dogs. His friends are then likely to question the sanity of a man who indulges in bullish talk or acts upon bullish conviction.
Carret highlighted a few methods used back then that proved to be consistently imperfect and costly to those too reliant on it. The idea that someone would put the fate of their financial well-being on something because it worked a couple times in a row, seems absurd. Yet, that’s exactly what happens. It’s almost like superstitious behavior.
Then, of course, is the issues in the last paragraph. The stock market is forward-looking. Changes in the stock market tend to precede changes in the business cycle. That never stops people from forgetting the cycle exists, getting caught up in the optimism near the top, or holding out for higher prices. The reverse is true near the bottom.
It’s no different today. The timing methods may have changed. Behavior has not. In both, the imperfection is still the same.
The Art of Speculation: Forecasting the Major Swings
Notes: The Art of Speculation by Philip Carret
Ben Graham’s Built-In Destabilizer of Markets
Howard Marks on Quantifying Risk