I recently came upon an article entitled “What You Can Do About The Upcoming Stock Market Crash”. The title was tongue in cheek and perhaps unfortunately so given recent events. Nevertheless, it made a number of important points about the difficulty of knowing when a market is at its peak and when a market is at its lows, and of knowing in which direction and by how much a market is going to move at any given point in time. Much of this I agreed with, but not all:
When you think about it that risk and fear will always be there no matter how far the market goes up, down, or sideways. So what can you do?
Be prepared for a crash at any time. If you need to withdraw money in the next few years or you want to cushion the blows, then you need to diversify your portfolio with enough bonds, cash, or other assets that won’t fall along with the stock market.
Once you figure out what is right for your current situation you don’t have to worry about what happens because you are controlling the risks instead of letting them control you. That means you are safe to invest your money today and start earning your way to the freedom you want for yourself and your family.
Points 1 and 2 noted above are more or less correct, but the last point I have emboldened is where I diverge. You are never ”controlling” risk, just diversifying it relative to return, and if possible, its covariance, itself a function of risk. You cannot control risk, only minimise its impact through structure. You are certainly not safe to invest your money today and there is no guarantee that you will earn your way to freedom.
Return is an important consideration when accepting risk and many today who use simple mean variance models assume that expected returns are invariant and that risk is only volatility around this return. In a general equilibrium, random, independent price movement model it does not pay on average to delay or defer investment (any benefit is purely attained by chance), but even here you are hostage to the probability distribution since the expected return in Monte Carlo land is only the average of many outcomes, some of which turn out to be quite disastrous from any level.
But expected returns do matter and while timing your investment to maximise your returns and minimise your losses is impractical and impossible for the market as a whole to do, making value judgements about market valuations and economic cycles to inform you of the boundaries of return and its significance is I believe worthwhile if you possess the expertise.. Where people run into trouble is where they either lack the knowledge and expertise to make the type of judgements needed to define the boundaries of expected return, and its impact on structure, as markets and economic cycles mature or react to market falls and meteoric rises as if one is the end of the world and the other its never ending bliss.
Deferring new risky investment at high market valuations is a value call and a discipline, but it is an act which relies on knowledge of the significance of valuation differentials. It is one of my concerns that “we” have been taught that we should invest in markets at all times irrespective of the valuation, the cycle and the specific characteristics of either. One of the reasons the world has been through innumerable crises since the late 1990s is because we have ignored significant accumulating structural economic and financial imbalances and the differential between asset valuations and economic fundamentals. In a well balanced world we could probably ignore valuations and invest at will, ignoring volatility.
But then again context is everything. While one may not invest/sell at cyclical highs/lows there is little reason to sell all (high) and then attempt to reinvest all (lows) at perceived key turning points. Portfolios should adjust to the relationship between valuation risks and the time frame of their liability profiles and it is here where we need to pay attention to valuation risks since these do have material impact. As markets rise returns fall and the risks to the ability of assets to meet future needs increases, and vice versa. When returns and risks pass barriers of significance that is where changes at the margin need to be made. It is therefore not a question of timing but of tangible discipline and its benchmarks.
And, of course, I believe we are in the middle of a very long period of global economic and financial fragility, so safe is a word I would eschew for some time.