CAN THIS KNOWLEDGE BE APPLIED?
Some of you may be tempted to think that it is easy to carry out market timing after having read the previous section. They may think that all one has to do is to take an index chart and draw in the trend line, making purchases or sales whenever the market price gets too far from the trend. There are, however, two enormous difficulties in trying to make market timing decisions based on past prices.
First, there is the problem of future changes in the companies’ business and political environment. The world of business is never static. There will always be changes, some small and some large to the environment which the companies operate in. In order for the stock market to perform as well as it had done in the late Seventies, the country must continue to prosper and the political climate has to be stable. How can we be sure that the future growth trend will be the same as in the past? In order to be a good forecaster, one must have a very good knowledge of economics and political science. This is hardly a qualification that is within the reach of laymen. Even with such qualifications, forecasting can still be very difficult. As explained in Chapter Six of this book, professional economists and moneymen can make collective forecasting errors very frequently.
Second, there is the problem of not knowing in advance how far will the market move above or below the trend. As we have seen from past records, the distance the market moved from the trend had been irregular and unpredictable. We can take the 1983 and 1987 booms as examples. Many professional market-watchers, including this writer, did not anticipate correctly the heights to which the market went.
Similarly, very few market-watchers anticipated the severe market declines of 1973 and 1985.
Last but not least, the market’s movements are not perfectly reflected in the movements of the individual share. Even during the sharpest decline, some of the shares hold their value very well. During a bull run, some of the shares do not go anywhere. At the same time, some shares magnify the movements of the market by two or three times, while others (mainly blue chips) only partially reflect the market movements. Thus even if we get the market timing right, it is not possible to match exactly what is achieved by the market. The relative position of a share’s price to its own intrinsic value is of equal if not of greater importance.
All in all, it is my opinion that market timing is more of an art than a science. There are some people who are highly gifted and are able to make good market timing decisions. And yet precisely because market timing decisions only have to be made once every few years, it is critical that they are made in the correct way. One wrong decision can either leave one out of the market for several years (i.e. after missing the start of a new bull run) or suffer heavy losses (i.e. missing the start of a new bear run). There are few of us who can be like Warren Buffett who made two timing decisions in 35 years and both of them were nearly spot on. We can never hope to be like Warren Buffett but we an use records of past market movements to help our investment decision making.
The most important use of past information is to tell us when the market has moved too far out of line. By looking at the chart, you Would have noticed that the price rises of 1972 or 1981 or 1987 were excessive and could not possibly be sustained. If we were rational at that time, we should have liquidated our holding and got out of the market. Similarly, in 1975 or 1976/1978 or 1986, by looking at the than, we could have seen that the market had become very undervalued and we should have increased our holding, even if it meant that we had to borrow money to do so.
For the rest of the time, we should buy individual shares as and When we believe they have become undervalued, keeping the chart in the background as a point of reference when we evaluate individual shares. So long as the market as a whole is not too far above the trend line, we can purchase shares which are undervalued according to our computation. Provided we are reasonably good in our valuation, the long-term improvement in the market should ensure that we make money over the long run. At times, the market may fall below or even well below the level at which we have made our purchases. This should not worry us because we have based our purchases on good dividend yield and we do not need to sell. Furthermore, we can take the opportunity to buy more shares and average down the prices of our fumes. Occasionally, we may even stand to make a lot of money by selling out if our chart tells us that the market has gone mad, as it is prone to now and again. We are therefore practicing a very defensive strategy, only buying if the shares are undervalued and quickly selling take advantage of the periodic bouts of market madness when they occur.