Don't Dump Your Stocks and Run for Cover

Pundits calling market tops shouldn't rattle your long-term investing plan.

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Daniel Solin
Daniel Solin

It is unfortunate that much of what passes for investment advice is misinformation, designed to cause fear and anxiety. CNBC recently asked whether things might be "too good to be true" for the U.S. stock market. As support for this premise, Paul Hickey, co-founder of Bespoke Investment Group, told the network he is concerned that "there doesn't seem to be any red flags out there" for the market. Why that observation is worthy of prime-time television escapes me.

Other factors leading to the conclusion that the stock market may be "overbought" is the high level of confidence of individual investors, the high valuation of the Standard & Poor's 500 index and a recent dramatic sell-off of Netflix, which could represent a weakness in momentum stocks.

Stock market pundits can get away with making predictions that would shame astrologers. Peter Boockvar, chief market analyst at the Lindsay Group, observed to CNBC that the market is "dramatically overbought" and could "flame out, but who knows when and at what level." Do you find that helpful?

MarketWatch columnist Lawrence McMillan also believes stocks are "overbought" but notes that the market could still "move higher" until "actual sell signals appear." He does not tell us what these "sell signals" would be.

I have no idea whether the market will take off or tank, but that's precisely my point. No one does. Relying on the musings of market "pros" is not an intelligent or responsible way to invest.

Stocks rose sharply Thursday following hopeful signs that a budget impasse in Washington may break soon.

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In no other area of human endeavor do we take at face value the unsubstantiated views of "experts." Instead, we should expect their advice to be based on solid research, reported in peer-reviewed academic journals.

It's not as if ample research is not available. However, because it does not support the views of the talking heads, it is rarely referenced. On November 28, 2007 (before the market crashed), Javier Estrada, a professor in the Department of Finance at the IESE Business School in Barcelona, Spain, published a paper entitled "Black Swans and Market Timing: How Not to Generate Alpha." He looked at more than 160,000 daily returns from 15 international equity markets. He found that missing the best 10 market days reduced returns by a staggering 50.8 percent. These days represented, in the average market, less than 0.1 percent of the days considered. Estrada concluded that the odds against successful market timing are "staggering."

The financial media encourage dumping stocks to avoid a "black swan" event like the one we experienced in the "great recession" we experienced between December 2007 and June 2009. It would be wonderful if we could predict when those adverse events were going to occur and sit on the sidelines until they pass. Estrada found that avoiding the worst 10 days in the market resulted in portfolios 150.4 percent more valuable than a passive investment. However, he found that these events are largely unpredictable. He notes that attempting to predict the "negligible proportion of days" when a severe adverse event will occur "seems to be a losing proposition." Instead of trying to predict the unpredictable, he counsels for broad diversification, which would mitigate the effect of black swan events.

When evaluating the often conflicting views of market pundits who are telling you they have a special insight into the direction of the markets, keep Estrada's wise words in mind: "Much like going to Vegas, market timing may be an entertaining pastime, but not a good way to make money."

Dan Solin is the director of investor advocacy for the BAM Alliance and a wealth advisor with Buckingham Asset Management. He is a New York Times best-selling author of the Smartest series of books. His next book, The Smartest Sales Book You'll Ever Read, will be published March 3, 2014.

The views of the author are his alone and may not represent the views of his affiliated firms. Any data, information and content on this blog is for information purposes only and should not be construed as an offer of advisory services.