Authors: Victor Hagani and James White, Elm Partners

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Download the research paper HERE

Does it pay to wait for a correction before investing in the stock market? No. On average, the returns forgone by being out of the market are greater than the losses avoided by not investing until after a correction.

Hagani and White examine 115 years of US stock market data using the following assumptions:

  • A “correction” is a stock market fall of 10%
  • An “expensive” stock market is one where the market’s long-term valuation-level[1] is one standard deviation above its long-term average
  • An investment horizon of three years

The authors found that:

  • There was a 56% probability that the market would experience a correction within three years
  • Being out-of-the-market (instead of investing right away) meant that investors avoided about -10% in losses
  • During the 44% of three-year periods with no correction, being out-of-the-market cost investors about 30% in missed gains
  • The mean expected loss cost of waiting for a correction (instead of investing right away) was -8%

The authors also tested different combinations of correction size (between -1% and -10%) and investment horizons (one, three and five years). They found that, in all cases, investors were worse off waiting for a correction before investing.

Expected Costs

 Author’s Conclusion

It’s true that the lower one’s expectation of the stock market return, the lower the expected cost of waiting for a correction. So, if you happen to believe the stock market has a negative expected return to a particular horizon, then waiting for a correction to invest makes sense. However, at least as far as the historical record for the US stock market goes, higher market valuations are consistent with lower prospective long-term returns, but not negative returns.

We’re not suggesting that looking at the historical record closes the book on the question of whether or not to wait for a correction. We firmly believe in the axiom that past returns are not indicative of future returns. However, we have the impression that some investors are waiting for a correction specifically because they think that history shows that waiting pays. We hope it’s been useful to show that history, for what it’s worth, is singing a different tune.

Takeaway

Investors should base their decision to hold less in stocks on reasonable estimates of risk-adjusted, expected returns. This includes considering valuation, market fundamentals and investor sentiment or behaviour. Simply waiting for a pull-back to buy in is a losing strategy.

Download a PDF COPY of this research summary 

Download the research paper HERE

[1] Measured using the Cyclically Adjusted Price-to-Earnings Ratio (CAPE) developed by Prof. Robert Shiller.

 

Grioli & Co. is an Authorised Representative (001258470) of Heuristic Investment Systems (AFSL: 276762).

 

Disclaimer

This web page is for educational purposes only. It does not constitute financial advice or take into account the particular investment objectives, financial situations or needs of individual readers. Readers should consider whether any opinions or recommendations in this document are suitable for their particular circumstances and, if appropriate, seek professional advice, including tax advice.

This web page has been prepared with care. However, Grioli & Co. makes no warrant of any kind in regard to the contents and Grioli & Co. shall not be liable for incidental or consequential damages, financial or otherwise, arising out of the use of this document.

This web page is not an offer to sell or the solicitation of an offer to buy any security in any jurisdiction where such an offer or solicitation would be illegal.

The price and value of investments referred to in this webpage and the income from them may fluctuate. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur.

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