Ask your typical financial adviser if retirees should try to “time” the stock market, and they’ll look at you like you’ve just grown a second head.
Conventional financial advice these days is that nobody should try to time the market, least of all safety-first retirees.
But white shoe Boston money managers GMO — most famous for their founder Jeremy Grantham and his terrifying jeremiads — are taking the other side of the argument. And they have a point.
First, though, let’s clarify what we’re talking about and what we aren’t.“Timing the market” is a loose term that means trying to cut your exposure to the market before it falls and raise it before it rises. It covers a variety of strategies, tactics and time frames.
At one end of the spectrum you’ve got people trying to day trade, or duck in and out of the market over short periods of time. Often they use technical analysis, “charts,” and various other forms of financial astrology to try to divine when the market is about to turn. This is generally a very unprofitable business, except for the brokers handling the trades on commission.
At the other end of the spectrum you have people who are moving slowly and thinking long term. They aren’t ducking in and out over days, weeks, or even months. They may raise or lower their exposure to the stock market from one year to the next, depending on whether they think stocks (and bonds) are overvalued compared with their fundamentals, or undervalued, or in response to economic or political risks.
People doing this may not even think of what they are doing as “timing.” They may actually object to the term, with its disreputable connotations of day trading. But anything involving cutting or raising stock market exposure temporarily, in the hope of profit and in response to market or economic conditions, is a form of timing.It’s this latter type that GMO is talking about.
Ben Inker, GMO’s co-head of asset allocation, and asset allocation team members James Montier and Martin Tarlie, have just published a paper that is likely to ruffle plenty of feathers. “Investing for Retirement III: Understanding and Dealing With Sequence Risk” argues that retirees can lower their risk of running out of money by including some market timing in their so-called “glide path,” meaning the path by which their portfolio is expected to evolve as they move through retirement.Right now, the retirement industry’s typical advice is that retirees should pretty much ignore temporary market conditions, and follow a predetermined optimal “glide path” from risk to safety, stocks to bonds, as they age. (There has been a lively debate about what that glide path should look like, but that’s another story.)
But as the GMO trio point out, these strategies and glide paths all rely logically on an unspoken assumption: That stocks and bonds are priced “fairly,” or (in layperson’s terms) “about right.” This is actually the great unspoken assumption underlying a lot of today’s financial advice: The “expected returns” and “risk” (i.e., volatility) of various assets at any given point is simply based on their average returns and volatility from the past 20, or 50, or 100 years.
This may end up working in practice — if readers will forgive me for using the same joke twice in a matter of days — but there is no real reason to think this works in theory. It was the great Greek philosopher Heraclitus who said that no person can walk through the same stream twice, because the second time it’s not the same stream, and you’re not the same person. Why should my expectations of returns from the stock market over the next 10 or 20 years be based on what happened during the Great Depression or the second World War, or the 1970s? And why should my expectations of future stock market returns go up the more expensive the stock market becomes? If we incorporate all historic data into averages, the massive bubble of, say, 1995-1999 actually raised the historic average stock market return, and therefore raised the expected future returns. Yet the common sense response to the mania was to think that the higher stocks soared, the lower their future returns. You can’t bank the same check twice.
This is where Inker, Montier and Tarlie come in. They argue that retirees can lower their risk of running out of money by “buying low and selling high.” When the stock market is expensive in relation to fundamentals, they argue, retirees should be adjusting their stock exposure downward. And when the stock market is cheap, they argue, retirees should be ramping their stock exposure up.
Such advice tends to run counter to modern conventional wisdom, which generally advises people to pick an asset allocation based on our individual circumstances and risk tolerance, and adjust it only as those change.
Inker, Montier and Tarlie run numbers based on a strategy that varies stock market exposure within a 20 percentage point band around a central “glide path.” Using historical data—there is that issue, of course, yet again—they reckon this more than halved the risk of running out of money in retirement even if you were using an aggressive 5% initial withdrawal rate.
The key moment of danger they were dealing with was the scenario that faced anyone who retired in 1970, arguably the worst moment, at least financially, in which to do so. Your 1970 retiree stopped earning and started living on their stocks and bonds just as both entered a decade of massive volatility and terrible losses. Stocks crashed in the middle of the decade. Bonds just died slowly, falling behind inflation year after year.
A 1970 retiree got hosed.
But someone who pared back their stock exposure in the early years, when stocks got expensive, and ramped it up mid-decade, when they got really, really cheap, did much better.
The GMO three argue that a big difficulty is going against our instincts: It is very hard, even emotionally painfully, to go against the herd and buy low (when everyone is gloomy and the natural instinct is to sell), and sell high (when everyone is bullish and the natural instinct is to buy).
But there’s a second problem with this strategy as well: It is very hard to find a reliable indicator that tells you when things are objectively cheap or expensive. So it’s going to be incredibly hard for retirees to know when they should be buying more stocks and when they should be selling.
The trio at GMO cite the famous “Shiller PE,” which is a measure popularized by Yale finance professor (and Nobel laureate) Robert Shiller, which compares stock prices to average corporate earnings over the past 10 years. The problem with the Shiller PE is that even though it proved a terrific long-term investing guide for the U.S. stock market from the 1880s to the 1990s, it has been of little use since. The Shiller data would have kept you out of the U.S. market for most of the past 30 years. There’s that philosopher Heraclitus again. For some reason, we’re not walking through the same stream.
There are no easy answers. But these experts raise a very good point: Most of these passive “glide paths” for retirees rely on the questionable assumption that assets are generally “fairly priced.”
Investors generally, including retirees, can surely help themselves by at least trying to sidestep the most obvious hazards. The most dangerous and craziest valuation bubbles are usually the easiest to spot. I can’t really think why an ordinary retiree, armed with nothing more than common sense, would want to invest in a skyrocketing Nasdaq bubble, or, say, in “inflation protected” Treasury bonds that actually guaranteed you would lose purchasing power.
Yet last year, alas, many probably did both, on the advice that markets are always fairly priced. The painful losses since should not have come as a surprise.