A cornerstone of Tarbox’s investment philosophy is to design a strategy based on the fact that nobody knows which stock, fund, asset class or market is going to perform the best over any short-term period. It’s difficult to decide when the market has reached its peak and it’s time to get out, and may be even harder to know when the worst is over and it’s time to get back in. Accomplishing both of these feats in the right sequence is extremely rare. (It has been said that “The market timing Hall of Fame is empty.”) Keeping this in mind is always important, but particularly so in an era where the bull market that started in March of 2009 is entering its 54th month.
A recent study emphasizes the fact that even market timers who got it right during the 2000-02 slide have, over the longer term, underperformed their counterparts who tried but didn’t get it right. The absolute winners? The non-market timers who knew it was fruitless to try a timing strategy, as shown in the following chart.
Source: Hulbert Financial Digest, WSJ, Tarbox
How could the market timers who gained such an advantage during the 2000-2002 sell-off manage to earn such long-term abysmal returns? They did not get back into equities during the subsequent rallies until it was too late. They only got one of the two big decisions right. Part of this may have been due to “terminal paralysis”, where those that played it right and avoided the crash looked good, but were afraid of risking their reputation by investing their stockpiles of cash too early.
Typically, “being out of the market” means sitting in cash and waiting for the optimal opportunity to buy back in to the equity market. Another way of “being out of the market” is to allocate assets from the equity market into other investment classes. A spotlight has recently been placed on institutional investors, most notably endowments, who have been gradually turning away from the U.S. equity market for the past decade, and shifting a significant amount of their portfolios into alternative investments. For example, the average college endowment had 16% of its investment portfolio in U.S. stocks as of the end of June 2013 (most endowments’ fiscal year end), down from 32% ten years ago, with 53% of their funds currently in alternative strategies. We believe that equities are the growth engine of the portfolio, and that alternative assets do have a place in client portfolios, but not as the predominant core. The chart below shows the five-year annualized return ending June 30, 2013 of four well-known Ivy League endowments (endowment returns are shown with the most recent data available) versus the Tarbox Moderate Growth Model Portfolio, whose return in comparison highlights the benefit of the Tarbox approach.
Source: Charles Skorina & Co., WSJ, The Tarbox Group; Endowment returns shown with most recent data available; estimated average return for endowments with assets in excess of $900 million ending Fiscal year 2014 is a little less than 16%.
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Some were swayed by headlines leading up to 2013, with financial journalists putting forth arguments heard regularly for the past several years (economic growth is well below average, stocks are expensive relative to earnings, earnings growth is too weak, etc.), and jumped out of the market. Yet we stayed the course and participated in the excellent equity returns that the U.S. market delivered.
Investors will always be tempted to believe that they can get into an asset class when it’s going up and get out before it heads south. At Tarbox, we know that it’s highly improbable that we (or anyone) would be able to do it successfully over a long investing horizon. Instead, we stick to our time-tested discipline.
