One of the most-repeated axioms in investing is “you can’t time the market.” While the prospect of buying stocks when they are about to go up and selling when they are about to go down may be tantalizing, studies have shown that even the most expert investors can’t do it.
A related concept is taking profits – that is, selling some of an investment that has yielded significant gains. Both concepts have taken on greater importance amid recent market gyrations.
Is taking profit a kind of timing the market? And if so, does that make it a bad idea? And does any of this change when market indices are still near record highs and more market downturns seem inevitable?
First, investors need a process and shouldn’t shoot from the hip, says Cameron Hurst, chief investment officer at Equium Capital in Toronto. In general, his firm is not a believer in taking profits in winning investments.
“Our process keeps us focused on leading positions while kicking out the weaker investments as they break down," he says. Rebalancing portfolios on a set schedule causes "the strongest positions to be reduced and weaker positions to be increased.”
In fact, this is exactly the opposite of what he believes makes for strong, consistent investment returns.
"The reality is markets can stay euphoric longer than perhaps they should, just as they can keep going down when indicators suggest they should be bottoming. We follow a process that reacts to markets as they are – not as we think they should be or predict they will be.”
As an example, Mr. Hurst points to the situation a year ago, when two of his firm’s top investments were the U.S. aerospace and defence sector and the medical devices and equipment sector. He notes that both were hovering around the high end of their historical valuation ranges. But the firm essentially maintained those positions, and the former returned 24 per cent and the latter 35 per cent over the year, both handily beating the overall markets.
No matter how much Equium loves specific investments, however, or how long it has held them, they will be sold when analysis says it’s time to go, he says.
The firm uses technical analysis to monitor its positions to ensure they continue to meet the parameters of their investment thesis, and it sells its positions as soon as they break technical thresholds. Mr. Hurst calls it an “unemotional process” that is critical to preserving capital and producing superior long-term investing results.
That analysis is designed to keep large positions from becoming a downside risk to overall performance. This is certainly different than taking profits just because an investment has gone up.
Colin Stewart, chief executive and portfolio manager at JC Clark Ltd. in Toronto, chooses a different approach when it comes to taking profits.
He says that his firm generally considers taking profits when a stock rises above the company’s intrinsic value.
JC Clark also pays attention to macroeconomic factors, market indicators, interest rates and overall market valuations. When the firm is concerned about them, it typically considers reducing position sizes, raising cash and hedging through the use of short positions.
“These types of tools allow us to maintain an investment in a business we like but reduce our overall exposure if we are concerned about market fundamentals,” he says.
Market fundamentals have certainly become an issue of late, with many world stock indices trading around record highs.
“When we see signs of euphoria and speculation in the markets – and there is certainly some evidence of this today – and overall valuation levels are extended, as they are today, we do recommend that investors take some money off the table and hold a larger amount of cash, or consider more defensive investments,” says Mr. Stewart.
JC Clark has been taking these steps of late, he says, which the firm believes will serve its clients well when the next correction inevitably occurs.
Chris Stuchberry also believes it can be appropriate to take profits. Mr. Stuchberry is a portfolio manager at Wellington-Altus Private Wealth in Toronto.
“Our approach is built on rules,” he says. “We do our best to follow the rules, and if we sell a bit off each time a stock makes a drastic move above what we believe to be its intrinsic value, we should avoid exaggerated pain from a drop.”
An example is one of the firm’s holdings, the U.S. tech company Twilio Inc. Mr. Stuchberry says the firm was showing “incredible” growth but the market wasn’t giving it any recognition. After successive earnings reports, however, he says the stock “gapped higher,” and Wellington-Altus sold some of its position, believing it was too much of a move away from its intrinsic value.
In light of recent stock-market highs, Mr. Stuchberry believes it’s prudent for investors to hold cash to offset risk. His firm increases cash balances as markets “get a bit frothy” and reduces when they “see real value.”
He notes that his firm is approaching a 20-per-cent cash balance that it will use to take advantage of a potential future downturn.