In our last post we looked at the problems associated with a 'buy and hold' investment strategy. We concluded that a buy and hold approach could only work if you made your investment at the right time, but unfortunately most investors don’t buy at the optimum point. In this post we'll look at reading the market and timing your investments.
Learning to time the market
Rather than buy and hold, when investing using ISAs and SIPPs, it's worth becoming more active and aiming to strategically time the market. In a typical 12 month period, we would generally make a couple of changes to our ISA and SIPP portfolio – making our approach fairly passive. We’ve found that overtrading cuts into your returns just as trying to time the market too frequently is extremely difficult to execute on a consistent basis.
During a bull market we’ll make on average one or two changes each year and what triggers a change is when we see underperformance from a fund we own. This happens because of sector rotation, which is when money moves from one sector and into another. For example, technology may be the hot sector for a while but eventually it has to cool off. As it cools, the next hot sector where you see big money flows could be financials. These hot sectors are known as leading sectors and all leading sectors eventually become laggards. This is the reason why it’s important to keep a close eye on which sectors are leading and which ones are lagging.
The aim is to keep a track of the money flow and try to always be positioned right in the middle of the money flow during a bull market. This is easier said than done of course but it should still be your aim. When a bull market is over and you believe a downtrend has been triggered, you could then move into cash and stay in cash during the full length of the bear market. Making better and more accurate timing decisions starts with understanding how the stock markets operate in cycles and how the majority of the daily trading volume is created by institutional involvement – large investors who have a significant influence on the markets trend and direction.
Do fundamentals still matter?
In 2003 the FTSE 100 bottomed at 3392 and in 2009 it hit a low of 3461. Who would’ve thought the FTSE 100 would revisit a similar price point again? Many companies since 2009 have been punished – good companies go down too. Some of world’s most idolised companies lost as much as 90% of their share value between 2008 and 2009 and that’s the reason why we all may need to look beyond fundamentals. Technical analysis is different to looking at fundamentals. It looks at chart trends and asks the question, is the market in an uptrend or a downtrend?
Is technical analysis the solution?
While technical analysis is not a perfect solution, it can often provide an effective way to help you gauge market direction and time your investments. It can also remove the emotional element inherent with stock market investing. Fundamentally, you can look at corporate profits, GDP growth, unemployment, inflation and price/earnings ratios to try to determine if the general market is under or overvalued.
Adding technical analysis to your tool box aims to keep you invested when trends are up. On the other hand, it also aims to get you out of the market when major downtrends have been triggered. Before you decide to invest, you could ask – is the market and the fund I’m thinking of buying in an uptrend? If the trend is up, you would have more confidence with issuing a buy order. If the trend is down you may decide to remain in cash until an uptrend had been established. In a down market, even funds run by star-performing fund managers follow the same direction as the market – just one of the reasons why our goal is to park in cash during bear markets.
Watch indexes more than economic data
Did you know that the market is six month forward-looking? Yes it is. This means you are going to struggle gauging future market direction if you use the news headlines and economic indicators to guide you. Using the news headlines and economic data to guide your investment decisions doesn’t work because the market will have already factored all the news and data into its current price. If you find the countless economic indicators confusing, join the club! How are you supposed to know if that industrial production figure was good or bad?
How should you interpret the jobs report? I’ve found that economic gauges predict the past or, at their best, the present. They won't really tell you the future. Often, by the time the economy starts cooling, stocks and investment funds will have already suffered a downturn. Likewise, a new uptrend can emerge while economic activity is slumping, or even as the economic cycle is at its worst point. There are two headlines that we pay notice to. The first is ‘Federal Reserve raises rates’ and the second, ‘Federal Reserve lowers rates’. The Federal Reserve are the US’s equivalent of the UK’s Bank of England and one of the Fed’s jobs is to decide if interest rates need to be changed. Interest rates are crucial to economic activity and to the stock market. The stock market loves rate cuts and hates rate increases.
The stock market has a personality
The stock market can behave in different ways. Sometimes its personality is friendly and the market’s the best friend you could ever ask for. Other times however, the market’s like the bully from hell who beats you up and steals your lunch. Funds have a personality and so do stocks. They act in a certain way and in bull markets, they tend to act well. In bear markets, they turn tail on you and drop like stones from the sky.
The only way to know if the behaviour of the market, stocks or your fund is normal is by watching their activity extremely closely. That means for indexes and stocks, watching the action whilst the market is open and analysing the market once it’s closed. Funds don’t trade in real time and so their behaviour needs to be analysed after the market is closed. You have to put in the time to really get to know the personality and character of the market so that when something changes you’ll know and you’ll be able to react quickly.
In our next post, we'll look at how the market works in cycles and how to analyse the market's health.
As always, if you have any questions or thoughts on the points covered in this post, please leave a comment below or connect with us @ISACO_ on Twitter.
ISACO is a specialist in ISA and SIPP Investment and the pioneer of ‘Shadow Investment’, a simple way to grow your ISA and SIPP. Together with our clients, we have £57 million actively invested in ISAs and pensions*.
Our personal investment service allows you to look over our shoulder and buy into exactly the same funds as we are buying. These are investment funds that we personally own and so you can be assured that they are good quality. We are proud to say that by ‘shadowing’ us, our clients have made an annual return of 12.5% per year over the last four years** versus the FTSE 100’s 7.4%.
We currently have close to 400 carefully selected clients. Most of them have over £100,000 actively invested and the majority are DIY investors such as business owners, self-employed professionals and corporate executives. We also have clients from the financial services sector such as IFAs, wealth managers and fund managers. ISACO Ltd is authorised and regulated by the Financial Conduct Authority (FCA). Our firm reference number is 525147.
* 15th November 2012: Internal estimation of total ISA and pension assets owned by ISACO Investment Team and ISACO premium clients.
** (31st December 2008 - 31st December 2012).
ISACO investment performance verified by Independent Executives Ltd.