Summer’s Dip Completes Round Trip, Again Proving Market Timing’s Perils

Can you hear investors’ collective sigh of relief? The S&P 500 is back at new highs after a W-shaped recovery from its summertime dip, which flirted with a full-blown correction (sharp, sentiment-driven -10% to -20% pullback) in early August. While there is never an all-clear signal for stocks, the two-month turnaround highlights how short-term volatility can both start and end unpredictably—and why short-term market timing is so perilous for investors needing equity-like returns over time.

As Exhibit 1 shows, when volatility strikes, headlines go into overdrive seeking eyeballs from suddenly wary investors, potentially stoking more fear—and further inflaming volatility, which lends fears more credibility than they arguably deserve. And they often keep hyping those things far into a recovery—well after markets have moved on. Short-term sentiment wiggles have little bearing on stocks’ longer-term direction, which depends largely on how well earnings expectations match reality over the next 3 to 30 months.

Exhibit 1: Bouncy Stocks—and Surrounding Headlines—Are No Reason to Quit Them

Source: FactSet, as of 9/20/2024. S&P 500 total return, 12/31/2023 – 9/19/2024. Headlines sources (in chronological order): Staff, The Economist, 7/16/2024; Michael Sincere, MarketWatch, 7/20/2024; William Edwards, Business Insider, 7/27/2024; Prashant Rao and Marta Biino, Semafor, 8/2/2024; Amanda Cooper, Reuters, 8/5/2024; Staff, Reuters, 8/9/2024; Bill Stone, Forbes, 8/11/2024; Carolina Mandl, Reuters, 8/12/2024; Alexandra Canal and Karen Friar, Yahoo! Finance, 9/6/2024.

The decision to exit stocks should always be forward looking, not a reaction to past market moves or stale news stocks dealt with long ago. Either you suspect a bear market (a fundamentally driven decline exceeding -20%) is developing—when most others don’t, as well-known fears lack surprise power—or your personal situation changes, requiring a lower stock allocation to meet new financial objectives. That may require adjusting cash flow (and spending) decisions, saving rates and more.

Absent those developments, getting out of stocks is usually a mistake. Too often, the urge to flee occurs just after a bout of sharp volatility. Cashing out then presumes you can get back in below or level with where you were before—and without volatility just resuming thereafter. This is extremely difficult, as sentiment-driven volatility can occur for any or no reason—and can flip on a dime. Moreover, there is an emotional challenge: If you exit because of a decline, how willing will you be to buy in when the decline has gotten worse? When dealing in hypotheticals, the allure of snapping up bargains is easy to cite. It is far harder to actually do, though.

Short-term timing rarely works out well. Consider a recent Morningstar study approximating market timing’s costs. It finds the returns investors actually earned lagged their funds’ posted returns by an average -1.1 percentage points annually—tied to “mistimed purchases and sales” from frequent trading.^[i] Now, the methodology here is imperfect. It uses fund flows (purchases and sales) to estimate investors’ exposures—and performance. It can’t fully account for how proceeds are reinvested (or not) after they sell. But this aligns with our experience, even if magnitudes vary.

Some may think the risk of missing returns is worth it since you aren’t earning zero on cash nowadays. But yields around 5%, while perhaps enticing when stocks were dropping, pale next to the bull market’s 64.7% return from October 2022 so far.^[ii] And while inflation has subsided, cash returns generally reflect inflation rates longer term. Its real returns (adjusted for inflation) gravitate to just above zero over time. Maintaining purchasing power isn’t nothing, but we doubt that is sufficient for most investors’ long-term financial goals.

Of course, volatility like we have experienced lately can be difficult—and can flare any time, for any reason. But time in the market is an individual investor’s greatest advantage, not timing it. Remember: Short-term volatility is why stocks’ long-term returns are high—the reward for investors sticking it out. While cash may seem comforting in the moment, its lack of volatility means there is little (real) reward for parking your funds there. This could make it harder to reach your long-term investment goals, raising your overall financial risk.

The solution, in our view, isn’t to tie your brain (or your stomach) in knots over short-term swings you will never know with certainty how to trade. Tune them out and look longer term. Are stocks likely to be up over the next 12 to 18 months? What, if anything, do you see that could end the bull market that others don’t? If sentiment isn’t euphoric and a global expansion-ending wallop isn’t evident, stocks probably move higher—and you shouldn’t be in cash. Ultimately, reaping stocks’ rewards to achieve your lifetime financial aims means not missing out on them. Staying invested during bull markets—and occasional bouts of volatility—is essential to that.