Euro Bond Returns, Timing The Markets

Interesting article from Bloomberg: http://www.bloomberg.com/news/2012-02-23/italy-defies-ratings-to-deliver-world-s-best-return-euro-credit.html . From the day when Standard & Poor's downgraded credit ratings of several European countries, including Italy and France, till now the bonds of those downgraded countries have delivered good to great returns. Italian bonds of over 1 year in maturity returned nearly 8% in just over a month! Remember, that downgrade was an event that was generally dreaded at the time as investors expected it to result in further price drops (and yield increases) for bonds of those countries. The exact opposite happened.

Nearly exact same story played about half a year ago when the US national debt ceiling drama was being played out in Congress. Standard & Poor's downgraded US credit rating from AAA to AA+. At the time news headlines were predicting veritable financial Armageddon as result of this downgrade and the related budgetary and debt issues. Instead both bonds and stocks have enjoyed tremendous returns since then (albeit with significant volatility).



Why does any of this matter? It matters because these seemingly counter-intuitive combinations of credit downgrades and rise in bond prices are an excellent example of market's tendency to be ahead of any and all events. Instead of leading the markets Standard & Poor's downgrades trailed it. The markets already discounted the risks before Standard & Poor's even started filing the downgrade paperwork. As the result by the time the downgrades were issued the markets have already moved on.

If professional credit rating analysts are unable to time the markets with any consistency, then what chance do you think Joe Schmoes has sitting at home has? The answer is pretty obvious there. Nevertheless millions of Joe Schmoes will try and roughly half of them will get any one market-timing decision "right". This will lead many or most of them to think they have real analytic skills and they will proceed to try to time the markets for years or decades to come, all the while getting about half right, half wrong, but always, always, always, paying countless friction costs of spreads, taxes, and commissions.

It's quite a sad story, because all those Joes genuinely believe that they are benefiting themselves by the inane buying and selling while in actuality they collectively benefit only the financial industry. With so many of them trying a few will, of course, obtain tremendous returns. But that is the equivalent winning the lottery and quite unlikely to be a reflection of actual effort and skill.