Market Timing – There is no crystal ball.

Just as it is impossible to reveal today what will happen tomorrow, it is impossible to predict with precision and regularity how any single stock or focused group of stocks will perform tomorrow and beyond.

“The press has an acute understanding of how most investors think—that you need to know the future in order to invest successfully. Therefore, they focus on making forecast after forecast. Traditionally they’ve done so by having their writers pick up the phone and call sources who profess to have a crystal ball. Often these sources are Wall Street analysts and brokers—the very same people who focus on making sales instead of giving solid advice.”*
Paul Samuelson of MIT received the Nobel Prize in Economics in 1970 based upon the straightforward concept that the efficacy of markets dictates that stock prices accurately reflect stock value and that future prices cannot be known or even reasonably predicted.**

Simply, a stock’s market price, what one is willing to sell it for and what the other is willing to pay, is the most accurate method of value determination. While the market price may not always precisely translate to precise market value, Samuelson stated there there was no better way to determine value. Active managers and investors assume this tenet of market theory false, use some “technique” to look for anomalies where price and value are disjointed and attempt to exploit the inconsistency by timing the purchase before equilibrium returns. Consequently, the media organizations which focus on investing use these “predictions” to entice the investor to buy their publications and read their stories and ultimately to participate in the inconsistent and unreliable realm of active investing. As you can see, this “process” is extremely conflicted and ultimately a great disservice to the investor.

Eugene Fama, of the University of Chicago (one of DFA’s founders), revealed his Efficient Market theory in the mid-sixties which was built upon the work of Samuelson and others. This theory states that stock market prices fluctuate randomly and are not predictable. Like Samuelson, Fama stated that the prices of stocks accurately reflect value. In efficient markets, information is cheaply and widely available in a timely manner to all participants and new information is almost immediately reflected in prices; the price itself is the method by which all information about that stock is communicated to the market. Fama explained that the only method to earn a greater than market return on investment is to increase risk exposure.***

So, if markets are efficient and stock market prices closely mirror stock market value via the fast and wide dissemination of information, what timing advantage does an active investor or fund manager actually have beyond reading tea leaves and chicken entrails? None, and more specifically their attempts at market timing put them at a significant disadvantage to those who cheaply and efficiently enjoy the consistent and reliable returns of the entire market.

• *Tools of the Trade: Don’t Believe the Hype, Daniel M. Wheeler
• **Proof That Properly Anticipated Prices Fluctuate Randomly, Paul Samuelson, Industrial Management Review, Spring 1965
• ***Random Walks in Stock Market Prices, Eugene F. Fama, Financial Analysts Journal, September/October 1965