LIVE MARKETS-What hurts more: missing the best or staying for the worst?

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WHAT HURTS MORE: MISSING THE BEST OR SUFFERING THE WORST?

With US stock indexes rising enthusiastically on Monday to snap a recent selling streak, it seems like as good a day as any to examine a recent Wells Fargo Investment Institute (WFII) study about the perils of trying to time market volatility.

The group's global asset allocation strategy team examined whether there is greater danger in missing the market's strongest days or getting caught in its weakest days and came to the conclusion that there is "some benefit to missing both the best and the worst days."

Here's their logic:

WFII notes that missing a handful of the market's best days over long periods "can drastically reduce" an investor's average annual return that they could gain by just holding tight to their stock investments during selloffs.

"Selling during a downturn and waiting to reinvest can also mean missing a meaningful portion of the recovery," they wrote.

But on the flip side, they argue that while missing the market's weakest days can potentially offer higher returns than a "buy-and-hold strategy," the problem is that "disentangling the best and worst days can be difficult." Part of the issue is that, historically, the weakest and strongest days have often happened around the same timeframe and "sometimes even on consecutive trading days."

So WFII points out that sharp volatility can "test even the most disciplined investment plans" as moving to cash might seem like a way to limit losses if prices are falling and uncertainty is high.

But they wrote that this approach "replaces one source of uncertainty with two difficult decisions" — when to reduce exposure and when the conditions are right to return.

Part of the problem is that the market can turn higher before the economic or investing outlook feels comfortable to the extent that much of a market recovery may already have happened by the time it is recognized as such.

Still, the group cautions that it is not advocating for investors to ignore changing risks. Instead, it says that it favors disciplined portfolio adjustments over "reactive all-or-nothing decisions made during periods of stress."

Part of the difficulty is that "the best days in the S&P 500 index have tended to cluster amid bear markets or recessions, when volatility is elevated, while some of the worst days have occurred during bull markets."

Of the market's 10 strongest one-day percentage gains, they note that 9 happened during recessions while 6 also coincided with a bear market.

And for example, 3 of the market's strongest 30 trading days and 5 of its weakest 30 days occurred within the 8 trading days from March 9 to March 18, 2020, during the COVID pandemic.

So the WFII strategists see this clustering as an argument for "most investors to remain invested through periods of high volatility."

To be sure, they say that reducing equity exposure during periods containing the strongest and weakest days may improve returns compared with being fully invested. But, in practice, the problem is that "investors cannot identify these days in advance." And they also note that the potential benefits would be reduced by trading costs, taxes and "the difficulty of determining when to rebuild exposure."

In the past 30 years, they found that waiting to reinvest when the market had recovered would have come at a cost because the S&P 500 had gained a median 24% from its trough to the date it recovered its previous high. While the investor would have avoided uncertainty, they would also have missed out.

So WFII's solution is to make tactical asset allocation adjustments "when an asset class is expected to under- or outperform over the next 6 to 18 months." But the key is to do that "without abandoning long-term market participation." That means staying diversified and "rebalancing when portfolio weights move away from long-term targets."

(Sinéad Carew)

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