Market Timing for Brilliant Children

I’ll put the postscript up front this time—if you’ve ever wanted to come to one of my gigs but were prevented from doing so by geography, check out my set at Night We Met in Nashville on SoundCloud. At 3 am, when the lights went on, the place was still packed and going nuts. While you’re there, give me a follow on SoundCloud. I’m just a few people away from getting to 3,000 followers, and I’d really like a shove.

Out of Stocks, Into Bonds

I’ve been writing about bonds for the last few weeks, and if you hadn’t noticed, the bond market has rallied quite a bit, and interest rates have come down.

John Mauldin and I made a bet—I bet him that the 10-year yield would touch 3% by the end of 2027. I gave him 2:1 odds. This was a few weeks ago, when rates were higher and the 10-year was at about 4.6%. I have a running headstart on this one. If I win, he has to donate $1,000 to my high school marching band; and if he wins, I have to donate $2,000 to the charity of his choice. I’ll be giving you constant updates on this, obviously, and winning the bet also comes with bragging rights and sack dances. I am going to be like Mark Gastineau in this letter.

I don’t want to beat a dead horse, but you have to say things six times on average before people listen: Get out of stocks and into bonds. At least a little. Take some profits, pay your taxes, and sleep a little better at night. You never know—you might find yourself with some handsome profits in bonds.

You know what else works? Mortgages. You don’t have to deal with the negative convexity since the majority of the population has refinanced into 2–3% mortgages. Mortgages will perform very well if rates come down. Munis also work. Stay away from corporate bonds and any structured products, which includes high yield.

And if you have no idea what I am talking about, take the Bond Masterclass!

Stock Exceptions

As for stocks, the index is still high, but if you dig down into the internals, a lot of stocks are acting terribly. Also, breadth is awful, and it has been awful for a while. None of this is new; market watchers have been yelling about this for months. And they were right, just early. 

I am bearish, obviously. Is there any place to hide? Well, defensives have been underperforming growth by about the largest margin in history. You could do worse than to just pick up some XLP (the State Street Consumer Staples Select Sector SPDR ETF). But that seems like a waste of time to me. Given a choice between stocks that are going to merely survive in a bear market versus bonds, which are going to thrive, I’d rather be out of stocks all together and be in bonds. I am making an exception for small-cap value and international small-cap value, but aside from that and a couple of idiosyncratic trades, my goal is to be pretty much completely out of US stocks. 

That’s the thing about me: When I do asset allocation shifts, I don’t nibble. I get aggressive. I have no problems moving almost my entire portfolio out of one asset class and into another. Don’t listen to the simpleton optimists on Twitter.

Market Timing

I will give you a sneak preview of my book that is coming out next year, the one after The Awesome Portfolio. It’s called Superinvestors. This is really interesting: I did some research to see if there had been any studies that showed a correlation between IQ and investing performance, the theory being that smarter people should perform better.

There was one study conducted in Finland, and in Finland, there is mandatory military service, and all the recruits take an IQ test. They then followed them after their military careers into their private life and looked at the performance of their brokerage accounts. Guess what? High-IQ people outperformed low-IQ people… by a lot (about 4.9% a year). And that was mostly because of market timing.

But wait, I thought it was impossible to time the market? Well, apparently it’s impossible if you’re dumb but not if you’re smart. The unstated conclusion here is that it is possible to market-time, which absolutely obliterates efficient market theory if smart people can do it. And you know the world’s great investors? They are all very smart.

The point here is that you probably shouldn’t spend much time thinking about how to time the market, except in very rare cases—like now. If you can do big asset allocation shifts at major turning points, that will have a big impact on your performance. You might only have to do one of these asset allocation shifts once every five to 10 years. I believe we are at such an inflection point right now.

Free advice, worth what you paid for it. I am also prepaying the bejabbers out of my mortgage, and I think you should do that too.

Jared Dillian, MFA