Why Most Investors Underperform The Market | Part 5: Timing The Market

This article is excerpted from an in-depth online course module first shared with members of my Quality Value Investing (QVI) subscription service in Seeking Alpha's Investing Groups on December 15, 2022, and January 17, 2023.

Most investors, whether retail or professional, underperform the market over time. As a result, they are perpetually craving new investing methodologies and stock-picking ideas for a straightforward reason: Their chosen approaches to portfolio management are not producing alpha.

In the final installment of a five-part series, Quality Value Investing (QVI) concludes its exploration of investment practices and schemes that challenge alpha instead of producing it.

Forgive the cynical approach; however, sometimes flipping the coin and looking at the negative aspects of an applied discipline such as stock market investing can be as impactful as the more positive attributes of discovering how to pick the winning stocks of enduring enterprises.

Preface

Out of respect for subscribers, followers, and new readers, Quality Value Investing rejects any short-term trading schemes for hopeful - although improbable - quick financial gains using controversial investment vehicles.

Hence, the service discourages options, futures, event arbitrage, currencies - whether crypto or sovereign - commodities, trend following, short-selling, technical analysis, swing trading, momentum growth, forward high-yield dividends, price targets or alerts, trading algorithms, margin accounts, deep value cigar butts, or any trading schemes deployed in the hopes of acquiring fast money. Instead, QVI concedes those speculative ventures to professional traders, market gamblers, and the Ouija board.

Throughout the article, whimsical references to the market represent the aggregate of fickle retail and aggressive professional investors who are lost in the crowd and ruled by emotions or greed when buying and selling investment securities.

Disclaimer: Although QVI takes a skeptical view of Wall Street - a euphemism for professional or institutional investing anywhere in the world - it neither implies nor expresses specific issues with or negative references to any actual organizations or individuals existing or working in the financial services industry. Any perceived connection or offense to actual firms or real persons is coincidental and unintentional. In its general lament of the Wall Street way, QVI abstains from unproven conspiracy theories and presents a narrative platform of commentary, critique, education, and parody. In a sane world, facts are exempt from any alternative paradigm; thus, the subjective thoughts shared throughout the article are QVI's opinions and, therefore, independent from fact.

They Ignore an Enduring Market Truth

Timing the market by chasing trends and fads is for fast money-seeking traders.

Before the coronavirus pandemic, Bitcoin was taxiing to be the next fall from grace. Nevertheless, the underperformers began loading up on the crypto in their perpetual chase for fast money. In the preceding years, similar plays such as subprime mortgaged back securities, zero-revenue dot-com IPOs, corporate junk bonds, and land deals in the western United States also permeated the get-rich-quick crowd. Several schemes fell between yesterday's barren land and the post-Great Recession bull market's Cryptonite. This time, the unfortunate pandemic and the cyclical 2022 inflationary bear market crashed the party.

From an investment standpoint, there are just a few market timers in each event who got in with a lucky twist of fate or the rare intuitive sense of market conditions, profited, and got out. Those are the ones who dominate the financial news feeds and the sponsored content, giving a false appearance of bullishness or bearishness in the market fad among the masses of well-intentioned investors. But, unfortunately, for most investors, market timing does not work.

The sobering truth reminds us that money-making headliners represent a tiny percentage of active participants. Too many players in the fad lose money and, again echoing the typical casino gambler, share only the rare winning bets. Just another reminder that market fads make money for a lucky few at the zero-sum expense of the silent investor majority that loses out from the desperate hope to make a lifetime of capital gains in a single market cycle.

The list of household names that made fortunes beating the market by owning investments with utility over extended periods is lengthy. However, it is almost impossible to name a celebrity investor who adds wealth year in and out on fast money, market-timing fads.

Yet, the narratives of get-rich-now by timing the market prognosticators continue to get a majority of eyeballs, including here on Seeking Alpha.

Why don't more investors follow the Warren Buffett of Berkshire Hathaway (BRK.A) (BRK.B) approach of buying quality at a reasonable price and holding for the long term, including forever, to take advantage of the magic of compounding?

Remember that Buffett did not reach his pinnacle of becoming a billionaire and a financial celebrity until his age 60's decade. When asked about this phenomenon, I believe Buffett's answer implied that most investors are not interested in getting rich slowly.

In the short term, speculators buy, sell, or short a stock in reaction to current events, expressing confidence or timidity by casting a vote reversed in a moment of breaking news, technical chart swings, or an earnings surprise.

Perhaps value investing is too long-term and low-cost for a nearsighted, over-sophisticated financial services industry bent on collecting exorbitant fees and bonuses from its legion of followers. Nevertheless, trying to predict trends, catalysts, and macro events that produce profitable trades with consistency befits a game of chance more than a legitimate professional practice.

The inherent risk to the value investing model is the speculative growth and high-yield income investors that permeate market cycles. Chasing the dragon during market bubbles has been a cornerstone of investing for Wall Street professionals and Main Street do-it-yourselfers since stock trading began. Unfortunately, human behavior dictates that it's off to the races once they outsmart the market and predict this swing or that trend or go long or short just right on a company or sector. Convinced of having this figured out, they begin the hamster roll of predicting and trading unrestrained.

They believe the trend is their friend. By definition, trend followers pass on the underfollowed player in an underappreciated industry. Nonetheless, following the trend or practicing momentum investing is fleeting, favoring nearsighted, speculative trades that come and go with market cycles and fads.

Skeptical, nearsighted investors cite political grandstanding, trade wars, commodity pricing dilemmas, livestock supply issues, occasional product recalls, and other inconsequential grievances to justify shortsighted momentum trades and trend following. And worse, offer death knell sentiments for companies domiciled outside the US.

It is incredible how seemingly a majority of the investment world believes the present market, whether bull, bear, or range-bound is somehow different, ignoring that business and market cycles come and go randomly. Having the newest and latest investment fad to rally around is their preferred differentiator, no matter the economic cycle.

They buy into the sophisticated financial models of sell- and buy-side analysts by attempting to determine the exact difference between the market price and the underlying value.

Over-analysis or setting price targets gets the underperforming individual investor - and perhaps the professional - in trouble from timing trades. Moreover, the analysis paralysis when researching publicly traded companies and their underlying stocks leads to extreme selling, shorting, or put options trades, as there is bad news in every security.

Suggested antidotes: Common sense dictates that a slew of short-term momentum trades are required to make the same potential profits from just a few long-term investments in the publicly traded shares of quality companies purchased at reasonable prices.

Savvy investors bought the winning holdings at value prices because the traders sold them off during a negative trend. So when you read, "XYZ is trading at a 40 percent discount to intrinsic value," remember how Wall Street justifies enormous fees and bonuses with predictions unnecessary in the scheme of things. If these market pundits were more often right than wrong, we'd become wealthy by following them.

Become a reformed and informed investor from lessons learned. Slow and steady investors know that stable companies appreciate in the long run, as the active trader moving in and out of positions in reaction to good and bad news gets punished in the short run. So we can follow populist stock trends to our portfolio's potential peril or invest in great companies over a long-term horizon and benefit from total return compounding with wide margins of safety.

Ben Graham taught me that "Price is what you pay; value is what you get." Whether we're talking about socks or stocks, I like buying quality merchandise when it is marked down.[1]

- Warren Buffett

Thoughtful, disciplined, and patient investors chase the enduring market truth of achieving a lifetime of alpha by accumulating the common shares of quality companies when trading at value prices.

Why Most Investors Underperform the Market

Here is a bulleted review of Quality Value Investing's five-part series of why most professional and retail investors underperform the market over time. The suggested antidotes are doing the opposite of each or simply avoiding the portfolio-sabotaging behaviors.

• Their primary objective is to get rich fast instead of the more viable investing approach of getting rich slowly.
• They lack thought, discipline, or patience, three of the most productive behaviors in the value investing paradigm.
• They buy into the Wall Street consensus that is often senseless instead of doing their own research and due diligence, such as reading SEC or similar international filings like the Form 10-K annual reports.
• Wall Street's fee magnet pulls them in repeatedly, supported by the talking heads on financial television because entertainment value prevails, with the investing world being no exception.
• They subsidize their financial advisors' sports cars and vacation homes instead of their own.
• The Wall Street fee machine convinces them that deep-dive predictive analysis is the best strategic vehicle for stock picking. But, on the contrary, Quality Value Investing has achieved alpha for 14 consecutive years by merely investing in the company's current wealth and the stock price's present value.
• They trade on emotion instead of principle.
• They passively index instead of actively hedge, thereby averaging to the market on both the exuberant upside and the nail-biting downside.
• They speculate in micro-caps, over-the-counter issues, and the shares of money-losing companies despite the availability of quality, profitable companies whose stocks are temporarily trading at value prices.
• They hunt risky, forward high-yield stocks to subsidize underfunded retirement accounts instead of heeding the more profitable total return model.
• They buy greed and sell fear instead of the lesser-used but more profitable strategy of buying fear and selling greed.
• They embrace the noise of Wall Street, ignoring economist John Kenneth Galbraith's largely undisputed assertion from 30 years ago: "There are two classes of forecasters: Those who don't know, and those who don't know they don't know."[2]
• They seek instant gratification from short-term bursts of growth-driven capital gains or forward high-yield dividend income. Nonetheless, it is almost impossible to name a celebrity investor with a household name who adds wealth year in and out on fast money, market-timing fads.

Ultimately, underperforming investors ignore the enduring market truth of "price is what you pay, and value is what you get."

***

1. Warren E. Buffett, Berkshire Hathaway, Inc., 2008 Letter to Shareholders, February 27, 2009, 5.

2. Tom Herman, "Weekend Report - 'How to Profit from Economists' Forecasts,'" The Wall Street Journal, January 22, 1993, C1.

***

What unprofitable investment practices in this series have you employed or observed in the past or present? What other counterproductive investing behaviors not listed above have you experienced or witnessed? How did or will you correct your approach to ensure more alpha?

Readers are invited and encouraged to share their investing experiences or lessons learned in the comments section below.

Copyright 2023 by David J. Waldron. All rights reserved worldwide.

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