Missing The Worst Days

In recent weeks, we have received quite a bit of mail from readers. Some were comments on recent articles; others were related questions. I must apologize for not answering all questions on a timely basis. After all, our main job is to manage our clients’ fortunes and writing always takes second place. Fortunately for my partners on Tocqueville’s investment committee, I am the one dealing most with \"strategy\" – and, since we do not publish our stock research, I am thus also the one who does most of the public writing.

One of the questions that tickled me came from a broker at Tucker Anthony. It did not only make me feel good that my investment alma mater still attracts thoughtful brokers – a phrase that is in danger of becoming an oxymoron. It also raised a valid objection to my dusting off old studies, in a recent article, showing that, over almost any meaningful period, missing the stock market’s best days had resulted in sharp reductions in investment returns. In essence, our friend asked: \"I, too have seen such studies. But have you ever seen a study showing the effect of missing the market’s worst days?\"

A legitimate question and no, I have never seen such a study. But while the question is legitimate, it is also a trick question.

Over long periods, and despite sometimes severe and even protracted bear cycles, the stock market has exhibited a clear secular up trend. Because of this (justified) upward bias, the opportunity loss of missing the best days, therefore, is likely to be greater than the savings from avoiding the worst days. In other words, the odds of betting on a bull market and those of betting on a bear market are not even.

When each attitude is carried to its extreme, for example, the results are dramatically different. An investor that remains invested at all times will suffer setbacks during the worst days but with overall investment returns that – given the right stock selection -- will approximate the market’s long term average of about 10 percent. Being totally un-invested at all times, on the other hand, amounts to owning treasury bills or the like, with much lower long-term returns. During not-so-distant times of higher inflation, bills were labeled \"certificates of guaranteed confiscation\", which was certainly true after taxes.

So, while being invested at all times deserves to be elevated to the status of an investment principle, being un-invested at all times does not. In fact, the only way to avoid the market’s \"worst days\" and still invest is to engage in market timing – another game altogether and one that, over time, has counted more losers than winners.

As a rule, we at Tocqueville do not attempt to time the market. This being said, as fundamental investors, we occasionally become aware that a majority of stocks have become grossly overvalued. This often happens after a long period of rising prices and near the top of a market cycle – although not always precisely so. Obviously, at such times, the potential penalty for missing a \"best day\" has been reduced, while the potential saving from avoiding a \"worst day\" has been increased commensurately.

Since such phases of market over-valuation also make it difficult for us to identify enough stocks to buy without bending our \"value\" investment discipline, our portfolios’ cash balances tend to increase as a result.

But, as I already said, we are not market timers and we are fully aware of the penalty for \"missing the best days\". This is why, without necessarily waiting for an obvious market bottom, we usually start reinvesting these \"accidental\" cash balances as soon as a significant market correction has restored reasonable values in enough individual stocks.

As previously reported before (see: What Surprise? and Are We Happy Yet?). This is what we started doing in the last couple of months.

François Sicart

June 26, 2001

^© Tocqueville Asset Management L.P.

The information contained herein has been obtained from sources believed to be reliable and to the best of our knowledge is complete. The validity and completeness however cannot be guaranteed by Tocqueville Asset Management. Nothing herein constitutes investment or any other advice and should not be relied upon as such. This document has been prepared solely for information purposes and does not constitute an offer or an invitation to buy or sell securities. Any reference to past performance is not necessarily a guide to the future. Tocqueville Asset Management L.P., their affiliates and their officers, directors, employees, advisors or members of their families as well as the clients for whom they manage portfolios; 1) May have positions in securities or options of issuers mentioned herein and may make purchases or sales of the securities or options while this publication is in circulation; 2) May hold directorships in corporations discussed in this publication. The opinions expressed in this document are those of Tocqueville Asset Management as of the date of the writing and are subject to change.