Friday Morning Coffee Nr. 34: Against the odds

301118 Friday Morning Coffee

Friday Morning Coffee Nr. 34: Against the odds

During Berkshire Hathaway’s annual shareholder meeting in 1994, Warren Buffett made the following statement on trying to predict the market: "I never have an opinion about the market because it wouldn't be any good and it might interfere with the opinions we have that are good". This quote resonates with us as we write the current column on the day after the perceived dovish comments by Fed Chairman Powell that made the Dow rally by 2.5% last Wednesday night. We are asking ourselves whether Europe is going to follow suit this Thursday morning or whether investors will be spooked by the gloomy Brexit analysis from the Bank of England.   We admit we are not good at predicting Thursday’s European close. After more than 20 years as an active investor, I personally still believe it is a vain effort to attempt to position portfolios correctly in the market for the short-term where anything can happen. In other words, market timing does not work, especially when including trading costs. The odds of getting the timing right are indeed extremely low for the upside of being right: the risk-reward relationship is not compelling. In the graph below, we looked at the price performance of the European markets over the last 10 years as represented by the STOXX Europe 600 Price Index excluding dividends. Source: ECP, Bloomberg. Data from 28/11/2008 to 28/11/2018. Past performance does not guarantee future results.   The portfolio of the long-term investor is represented by the blue line: by staying fully invested his initial 100 EUR have grown to 173 EUR in the decade since the financial crisis. Our second investor is a “star trader” and has with his trading skills been out of the market on each of the 10 worst trading days over the last 10 years. One of the worst days occurred in 2008, two in 2009, four in 2011, one in 2015 and the remaining two in 2016. He was fully alert on these specific days at his desk and got out of the market for the day with no transaction costs and then back on the very next day.   What are the odds of getting 10 days right in a chronological time series of 10 years? I asked my most statistically skilled colleague at ECP, our risk manager Thierry Klaa, to compute the odds. According to him, the probability is lower than the 1 out of 139.838.160 odds of winning the Euromillion jackpot ! On the flipside, there is a heavy cost if our star trader gets it wrong. Imagine an unfortunate situation he is out of the market on the 10 best performing days. The initial 100 EUR will be worth 109 EUR after 10 years as represented by the green line. At ECP, market timing is not within our circle of competence. We invest in what we consider undervalued businesses with a time horizon of 4 to 5 years. In our strategy we try to exploit market volatility to find new investment opportunities the stock market offers to us. That is completely different than trying to time the market against the odds.   We prefer to think about company fundamentals rather than spending excessive time trying to forecast short-term stock market moves.