No one ever said that market timing is easy. One reason for the high failure rate is that market prices incorporate new information almost instantly; another is that prices often react in unexpected ways. For example, in just the last two years, we’ve experienced the contentious 2016 election, rising interest rates, tensions with North Korea, military action in Syria, an overhaul of the US tax code, and the fallout from the UK Brexit vote. Throughout these events and others, stock market prices have reacted very quickly, and often in ways that contradicted “conventional wisdom”.
More recently, market participants have also been surprised by the US stock market’s reaction to escalating trade tensions between the US and China. Instead of declining on fears of a protracted trade war with China, we stand once again at all-time record highs in most US equity markets. Shouldn’t tariffs be “bad for business”? If so, why does the ‘market’ appear to be ignoring this development?
While it is always risky to ascribe short-term market movements to any particular news item, it is possible that markets have been able to shrug off trade concerns for any of the following reasons:
- The United States imports more than $500 billion of goods from China each year, but current tariffs only target roughly half of that amount, and at a fairly low rate. The market might believe that we’ve already seen the worst and that China won’t retaliate further.
- The latest round of tariffs announced (10% on an additional $200 billion) have only been in place since September 24. The market may expect the latest escalation to be relatively short-lived.
- The market might also believe that even the “worst-case scenario” is tolerable. If the US decides to impose crippling 25% tariffs on literally all imported Chinese goods, the total dollar amount would be roughly $130 billion annually. This figure, albeit large, represents less than 1% of the $20 trillion US economy. While certain industries may suffer, the market may surmise that the economy as a whole can absorb a one-time shock of this magnitude.
- The domestic economy happens to be particularly strong at the moment, and looks poised to post back-to-back quarters of >4% GDP growth (in Q2 and Q3). Therefore, the market may believe that our economy is resilient enough to weather large tariffs even for an extended period.
- In the last six months, the US Dollar has appreciated 8.3% against the Chinese Yuan, which actually negates much of the higher costs on tariffed Chinese goods.
- Finally, markets tend to be forward-looking; regardless of what’s happening at the moment, prices are constantly discounting the likelihood of future events. In this particular case, investors may already be looking forward to the end of the trade wars (and the relief this should bring).
I’m sure there are many other possible explanations but the main point to keep in mind is that market prices incorporate new information very quickly, including potential future states of the world. This is why markets don’t always react in expected or predictable ways – and also explains why ‘market timing’ is so difficult. Attempting to buy and sell stocks based on the news of the day is likely to be an exercise in frustration, not to mention a very costly trading strategy! Fortunately, evidence-based investing shows us that success is not determined by our skill at “timing” the markets, but by how much time you commit capital to them as an investor.