David's Weekly - Sep 1, 2023

Plan - Don't Predict

As we approach the end of summer vacations, we'll focus our final brief letter with some advice that we can put to work as we head into the busier months. In particular, we'll revisit the important topic of market timing and it's perils and also touch on some investment strategies that actually work. With a refresher on risk management, we'll head into the new "school" year ready to face new market challenges. Please enjoy the letter and have a great long weekend.

Can the market be timed?

Before we get into the discussion that follows with some ideas and recommendations on how investors might adjust their portfolios during this part of the cycle, we'd like to pull back and talk about the holy grail of investing: Market Timing. Can it be done? Depends on how you define timing.

If you look at market timing as being in the right place at the right time and being out of the wrong place at the right time, then, yes, timing is nigh on impossible. We would posit that picking market tops to make sales and market bottoms to make purchases is beyond the ability of humans to accomplish, primarily because we cannot possibly know what will happen next in a free market.

Betty Boop and her advisor divining when she should go to cash and then when to reinvest

Psychology plays a huge role in this inability because it's human nature to do the opposite of the right thing when it comes to investing. When markets go up, people get greedy and try to chase a winner. When markets swoon, people get fearful and typically liquidate at the absolute worst time. The chart below shows the crowd selling into the lows, an activity as old as the hills and as persistent as eternity. As we oft quote from our friend Dennis Gartman,

"When they're yelling you should be selling, when they're crying you should be buying."

Dial 1 800 GET ME OUT! COVID Market Sell-Off - Biggest Volume at the lows when the humans capitulate

The graphic below shows one way of viewing the risks of market timing. Market timing is often used to estimate exactly when the market will peak, with the assumption that after exiting, one will re-enter the market at a more favourable valuation. The trouble is that it is hard enough to execute the first trade, the "exit", but even harder to get back in as one waits for the exact low. The risk is that while you wait for the perfect time to get back in you risk missing the most important moves back up, hence, the adage, "ride it out". The below is based on the annualized returns of the S&P/TSX Composite Index for 10 years, ending January 31, 2022.

Missing just a few of the good days can really hurt your portfolio

In effect, market timing is an attempt to reduce risk which is a reflection of the possibility of numerous outcomes, some good and some bad. Higher risk means more possible outcomes. Lower risk implies that the range of possible outcomes narrows.

Ideas to manage risk

Given that market timing is a tough system to handle risk, let's talk about a few ideas to manage risk.

Hold a diversified portfolio:

The benefits of maintaining proper diversification help ensure that the value of your portfolio doesn't all ride on one security, sector, geography, or style. One can never tell which of the latter elements of a portfolio will outperform or underperform from one year to the next. Placing all your chips on one number puts you in a "go up or blow up" situation". In contrast, broad-based investing opens the opportunity to have at least some parts of your portfolio benefit from the market cycle to manage the inevitable components that experience adversity from inflation, exchange rate, credit, interest rate, and market risk.

Review your portfolio at regular intervals

At least once a year, review whether your portfolio is still aligned with your personal circumstances and goals including needs for growth, income, liquidity, and/or capital preservation.

Keep on top of your own comfort with risk to avoid emotional investing

Down markets engender fear while up markets trigger greed and this cycle naturally impacts one's risk tolerance. So, it makes sense to regularly ask yourself honestly if your portfolio is still suited to your needs and your broader financial plan. Without a clearly defined risk tolerance, as expressed through an investment policy statement, emotions can take over and cause one to buy at the highs or capitulate at the lows.

Stick to investments that you can understand

Nothing can cause more hype than magical, "new-economy" investments which trigger the "animal spirits" that can cause markets to over-heat. Do you understand and recognize the value and pros of cons of investing in crypto currencies or artificial intelligence startups? You might. But if you don't, best to stay clear. If you don't understand an investment, all of your decision-making will be driven by emotions and that is a recipe for losses.

If you are considering reviewing your own portfolio or have questions or concerns about your own planning, please get in touch: [email protected].

And with that, we'll wind up as always with the RBC DS Global Insight Weekly.

Thanks for reading.

In this week's issue...

• BRICS: What’s all the fuss about?:?The loose association of developing nations is preparing to welcome up to six new members, while developed economies are coming to terms with a significant shift in the geopolitical and geo-economic landscape. We look at how the emergence of new relationships could shape the future.
• Growing expectations for an economic soft landing in the U.S.:?Labor force participation rose and inflation slowed in July, while recession expectations dropped to the lowest level so far this year. We think strong consumer spending may weaken in the coming months.

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