Wouldn’t it be great if you knew the future before it happened? Imagine all the money you could make in the stock market. It seems like a dream scenario, right?
But, what if I told you that it wasn’t true? What if “knowing the future” wasn’t as profitable as you think?
It might be hard to believe, but I can prove it with a game.
The Market Timing Game
Imagine it’s February 28, 2020. The COVID-19 pandemic has just started to spread around the world and the S&P 500 is currently down around 12%. Given the uncertainty, you decide to get out of the market.
But now imagine that a magic genie comes to you with a proposition. The genie will give you the actual headlines through the rest of the COVID-19 pandemic. You’ll know whether we find a vaccine (and when), roughly how many people die, and when it all ends.
However, if the genie provides you with this information, you have to decide right then when to reinvest in U.S. stocks. You can’t wait and see what prices do. You have to pick a date to re-invest based solely on the future headlines provided. Do you accept the genie’s deal?
Let’s pretend you do. As promised, the genie gives you the following set of headlines, which I selectively sourced from the CDC’s website:
- March 11, 2020: After more than 118,000 cases in 114 countries and 4,291 deaths, the World Health Organization (“WHO”) declares COVID-19 a pandemic. The NBA cancels the rest of its season. Within the next few days, the Trump Administration will declare a nationwide emergency and states will begin to implement shutdowns in order to prevent the spread of COVID-19.
- March 17, 2020: Moderna Therapeutics begins the first human trials of a vaccine to protect against COVID-19 at a research facility in Seattle, Washington.
- April 10, 2020: With over 18,600 confirmed deaths and more than 500,000 confirmed cases in under four months, the U.S. is the country with the most reported COVID-19 cases and deaths, surpassing Italy and Spain as a global hot-spot for the virus.
- May 28, 2020: The recorded death toll from COVID-19 in the U.S. surpasses 100,000.
- September 28, 2020: The reported death toll from COVID-19 reaches more than 1 million worldwide (with 200,000 deaths in the U.S. alone).
- November 16, 2020: Moderna’s COVID-19 vaccine is found to be 95.4% effective in its clinical trial. Two days later, Pfizer-BioNTech’s COVID-19 vaccine is found to be 95% effective in their 44,000-person trial.
- December 14, 2020: The recorded death toll from COVID-19 in the U.S. surpasses 300,000. Sandra Lindsay, a nurse in New York, becomes the first American outside of clinical trials to receive a COVID-19 vaccine.
- January 16, 2021: More than 23 million COVID-19 vaccine doses have been administered in the United States. The number of recorded COVID-19 cases worldwide surpasses 100 million.
- February 21, 2021: The recorded death toll from COVID-19 in the U.S. surpasses 500,000.
- March 13, 2021: More than 100 million COVID-19 vaccine doses have been administered in the United States.
- April 21, 2021: More than 200 million COVID-19 vaccine doses have been administered in the United States.
- March 3, 2022: The U.S. has now donated more than 480 million COVID-19 vaccine doses to 110 countries.
- June 1, 2022: The U.S. has recorded a total of 84,145,569 COVID-19 infections and 1,003,571 deaths from COVID-19.
- May 5, 2023: The WHO declares that COVID-19 is no longer a public health emergency of international concern.
After seeing these headlines you are relieved that we find a vaccine and mass produce it, but also horrified that over 1 million people in the U.S. die from COVID-19.
Nevertheless, since you accepted the genie’s deal, you have to pick a date to reinvest your money. Using just the headlines above (and ignoring what actually happened in the market), what date would you have picked? Be honest.
I would’ve picked November 15, 2020. That was the day before the 95% effectiveness of the initial Moderna trial was announced. That’s the first overwhelmingly positive information among these headlines. Was that the ideal choice?
Nope. I would’ve missed out on a 23% gain (from February 28, 2020 to November 15, 2020) by reinvesting so late. For those who remember their market history, the S&P 500 bottomed on March 23, 2020. Therefore, the correct answer from the list above was March 17, 2020.
If you had reinvested on March 17, 2020, you would’ve had a 43% gain through November 15, 2020:
What was happening around March 17, 2020? That was when Moderna first started human trials for their vaccine. They didn’t know it would work. No one did. At the time, the death toll in the U.S. was less than 2% of its eventual total. Yet, that was the best time to invest.
When Having the Answer Doesn’t Help
Do you see how insanely difficult market timing is? Even when I give you the answer (i.e. headlines from the future), you’re likely to still get it wrong. There are very few disciplines where this is true, but investing is one of them. It reminds me of the time that Jane Street Capital learned of Trump’s 2016 election win minutes before CNN and still managed to lose $300 million on the trade.
I’ve spent years of my life making technical arguments against market timing (see here, here, here, and here). I’ve (hopefully) demonstrated that such strategies are subpar compared to simply buying every month (i.e. Just Keep Buying).
But this post makes a logical argument against market timing. There’s no need to compare one strategy to another. You can intuitively see why it’s an impossible game.
The truth is that the market is an extraordinarily complex discounting machine that brings all information (and expectations about that information) into prices almost instantly. As Barton Biggs stated in Wealth, War, & Wisdom:
Markets function so efficiently because the totality of all relevant information including subjective preferences are aggregated through the price mechanism into a single market valuation which, while perhaps not perfect, is better than any number concocted by a human entity or even a computer.
This is why a headline about the future won’t tell you much about what the market will do.
Because a headline is just a first-order effect. It’s the initial information about something. What that headline misses is how investors will respond to it. It also misses how investors will respond to the response. And so forth. It’s these higher-order effects that can’t be determined from a single piece of information.
In other words, even if you know the future, you don’t know how others will react to it.
That’s why no one will ever be able to consistently time the market. Because all the information you’d have to know is, by definition, unknowable. The market is a chaotic system, meaning that even the smallest change in initial conditions can drastically impact how it responds to information (i.e. the butterfly effect). This is why you can’t time the market, even when you know the future.
But, in reality, you won’t know the future. The genie with tomorrow’s headlines doesn’t exist.
I know how hard it is to resist the temptation of market timing. I even sinned a little myself recently.
However, I was wrong! The market moved upwards anyway.
While AI valuations still seem very optimistic (read Aswath Damodaran’s recent piece to see why), it’s obvious that I can’t outsmart the market. So, for now, Just Keep Buying and thank you for reading!
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This is post 486. Any code I have related to this post can be found here with the same numbering: https://github.com/nmaggiulli/of-dollars-and-data
