It seems hard to believe, but 3 years ago last month, famed investor Warren Buffett wrote a widely circulated editorial in the New York Times entitled “Buy American. I am.” The column discussed the chaotic crash in stock prices that was unfolding before our eyes. Today, market participants simply refer to the period as “2008.” At the time, no one knew exactly what it was. Many suggested it was a crisis of confidence. Others argued it was a total failure of the financial system. Some believed it was the start of a second Great Depression. In October 2008, Buffett saw the environment as an opportunity to invest his personal savings in the stock market.
The article conceded that the economy was a mess. Buffett predicted that unemployment would rise, output would slow, and nerve-wracking headlines would persist. If Buffett were a fortune teller, his predictions would deserve high praise. Each one came true. Nevertheless, despite this gloomy economic outlook, he was actively buying stocks as prices plummeted.
Logic would ask, “Why invest money in the stock market if you believe the economy to worsen?” The answer is that the stock market does not behave rationally. It never has. Instead, the market anticipates economic growth or contraction well before it actually occurs. For this reason, timing the market based on daily economic readings is akin to arriving at the World Series after the first eight innings have been played.
In the chart below, the Dow Jones Industrial Average is plotted alongside the average annual employment rate (i.e. 100% minus the unemployment rate). Seven peaks/troughs in the employment rate are labelled as (1) through (7). With the exception (2), notice that the Dow Jones began to anticipate a change in direction of the employment rate long before it actually happened.
In October 2008, when Buffett forecasted further economic contraction at the same time that he also purchased stocks, the US unemployment rate was 6.5% and the Dow Jones stood at 8,850 points. One year later in 2009, unemployment approached 10% but yet the Dow Jones had now surpassed 10,000 points. In other words, the unemployment rate grew from 6.5% to 10% but yet the stock market appreciated 13%. Overall, it is fair to say that timing the market is a speculative game.
