In mid of February this year the domestic equity market peaked in terms of price and has corrected at least, 8% so far. This gives a good opportunity for those who missed last year’s uptrend, to invest when prices have fallen.
To invest more, you need to have what market players call – dry powder or cash. Some would say one should have sold when the market was at its peak and used that money to reinvest in equity as prices are falling.
This is a strategy that helps you increase cash allocation in market peaks, ready for reinvesting when the market prices are close to their bottom. Is that a strategy worth following and can it be done?
Timing the market
To be able to gather cash at market peaks by selling some of your existing equity holdings, you need to know the peak approaching, before it actually does.
This is much easier said than done. In hindsight, we can all identify the peak, but while there, it’s hard to tell whether the next turn will be going down or up.
When the market crashed slightly more than a year ago, in March 2020, there was no one who was able to foresee the sharp uptrend in the next nine months. Had you sold in the peak of February 2020 and bought in March 2020 at the low point of the market, it would have meant an extraordinary gain by the end of the year.
Hardly anyone did that because it is practically impossible to tell the peak or the bottom beforehand.
In February 2000, more than two decades ago, there was a market correction that started and lasted 19 months, before an uptrend was seen. However, the good days did not last long, as another long correction started within six months and continued for another year and a half. Only by April 2003 did a sustainable uptrend begin.
While you may have estimated the overvaluation and subsequent peak in 2000 with greater accuracy, would you have foretold the bottom or that the correction would last three years? It’s highly unlikely. Even if you had cash on the side to reinvest, most of it would be done in the first six months of the correction.
What happened last year was the opposite, if you had that extra cash allocated at the peak of the market, waiting for the downtrend, you wouldn’t have been able to reinvest even 50% of that given that the downtrend itself was very short-lived.
The opportunity cost of keeping cash
Keeping cash in the hope for the right level to reinvest has a cost attached. If the market uptrend remains for longer than you expected, or if the market peak is reached six months after you anticipated it, you are losing potential growth on the amount you cashed out. The lost return is the opportunity cost.
In October 2020, when the benchmark indices had rallied slightly over 50% in seven months since in the bottom, it seemed that it was surely a peak, at least in the short term. Plus 50% return in seven months is a lottery you don’t risk. However, the market rallied another 30% before it has corrected and even now we aren’t at the level of October 2020. Had you sold back then in an attempt to preserve profit and reinvest later, you would have only lost the additional 30% return in the next four months.
That is the opportunity cost of making such short term allocation changes; predicting market levels in hope for making the most return is wishful.
Had you done nothing in February 2000 and remained invested for the next 10 years till February 2010, you would have made roughly 12% annualised return and again around the same had you remained in the market till now.
When it comes to investing in equity, doing less makes you more return. Increasing allocation to cash in anticipation of peaks and bottoms is a risky strategy that has an equal chance of backfiring as it has of coming through the way you expect it.
It’s best to remain invested for at least 7-10 years if you want to benefit from efficient equity market returns.