Market Timing or Not? You Decide
As Merlin says, there have been some good discussions on this topic here over the last several months, although (he admits rather shamefacedly) I can't seem to track them down at the moment. Still, let me offer a conceptual distinction that might help clarify things.
I think a buy or sell decision can be said to be based on market timing when the chief factor behind the decision is an expectation of a significant shift in stock price in the near-to-mid-term, independent of significant company-related developments.
A buy or sell decision is not based on market timing, in contrast, if the chief factor behind the decision relates to a recent or imminent significant company-related development, a portfolio rebalancing strategy, the finding of a better investment, or personal reasons (such as a need to raise cash).
Valuation-based decisions are almost the only kind that don't fit neatly into one or the other category, but, I submit, need to be treated on a case-by-case basis.
I seem to recall Buffett saying something along the lines that there are only three components of a stock's price: the company's expected earnings stream, the price people will pay for that earnings stream, and interest rates (which affect the value of the earnings stream relative to a bond).
Clearly, buy and sell decisions related to changing views of the company's future earnings are not market timing, nor are decisions related to entirely exogenous factors (a planned trip to Cancun, a sudden illness, Vito knocking at your door, etc.). The question is, what about decisions related to one's views about changes in valuations or interest rates? I say those should be considered market timing in some cases but not others, as the following examples illustrate.
Case 1: Moe thinks company X will have excellent earnings in years to come, and believes that the stock's current P/E multiple is toward the bottom end of a reasonable or historical range--so he buys some shares. This is not market timing, in my view, because Moe is buying for long-term earnings and using the present relatively low valuation as his "margin of safety."
Case 2: Larry thinks company Y has mediocre prospects, but believes Y's entire sector is ludicrously undervalued because it is so boring and untrendy. He further believes that the market is overdue for some sector rotation, in the course of which Y's sector will stage a revival and thus Y's P/E multiple will rise back to a normal or reasonable level--so he buys some shares now intending to sell them at that point. This is market-timing, in my view, because the raison d'etre for Larry's swing trade has to do with a near-to-mid-term change in what other people are prepared to pay for a fixed quantity (Y's mediocre earnings stream).
Case 3: Curly has been watching company Z for a while; last summer he bought half a position but is still waiting to buy the second half. He thinks Z's future is great, but is hesitant to buy now, however, because Z--a red-hot media fave--carries a lofty P/E. So he decides to sell what he has and buy back in at a better price further down the road, once the bubble has finally been wrung out of the market. I think this is also market timing, because Curly's decisions are based on his expectations of what the market will do, not what the company will do.
Case 4: Like Curly, Shemp also holds shares in company Z. But he bought them long ago, back when nobody had heard of Z or even its subsector and the price was a steal. Shemp is pretty risk averse, and has become increasingly uneasy at Z's skyrocketing valuation--not because he thinks he knows what's going to happen next, but because he makes it his practice never to hold something whose current price far exceeds the present value of future expected cash flows. When he first bought Z this was not a problem, but the stock rose so far so fast that it is now--so he decides to sell. I think this is not market-timing, because the decision is ultimately based less on Shemp's expectations of what others will do than on strict adherence to his own predetermined criteria for what kinds of positions to hold.
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Case 5: John has his eye on companies P, Q, and R, but looks to things besides company-specific factors when making purchase decisions. As he puts it, "I am looking for a macro indicator. Something that tells me where the whole market is going to go....If the economy (calculated as a whole) isn't worth what is being paid for it at the moment (calculated as the sum of the parts)...then something is bound to give in the long run. Either the price will correct, or the economy will correct. Or both. Reversion to the mean or revision of the mean. The principles of free-market economics have not changed since biblical times, so expect the mean to remain constant. Presto. Price corrects." So he decides to hold off purchasing things for now, confident that prices will be lower (for P, Q, R, and lots else) down the road. Guess what, John--it's market timing...(not that there's necesarily anything wrong with that, if you--unlike the rest of us--can actually pull it off).
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