Market Timing: Should You Attempt It?
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» KLR - Preparing for the coming 100-year depression
The ultimate bear market portfolioPreparing for the coming 100-year depression
By Paul B. Farrell, CBS.MarketWatch.com
Updated: 9:24 PM ET Nov 4, 2001 Printer-friendly version
LOS ANGELES (CBS.MW) --I'm an optimist at heart. Although I believe the battle between good and evil never ends, I know that in history, the good guys eventually win, and the dark side loses. It's the same with the economy and markets.
But Sept. 11 shook my faith. Doubts flooded in. I got thinking about the 100-year global depression Robert Prechter predicted several years ago. What would this super-bear's portfolio look like now?
So you don't remember Prechter, America's darkest super bear? Prechter publishes The Elliott Wave Theory newsletter. His 1995 book "At the Crest of the Tidal Wave: A Forecast For the Great Bear Market," predicted a 100-year global depression. He sent a review copy while I was publishing my Future News Index newsletter. Many other timers were predicting a crash and an "historic turning point."
Super bull turns super bear
I respected Prechter's theories, because he wasn't always a super bear. When I joined the old Financial News Network in 1982 the Dow Jones Industrial Average bottomed at 777. At the time, Prechter was a rare prophet predicting a bull market.
In 1995, he became a super bear. Two years later, Money Online wrote this about Prechter: "Not even a retreat to 4,000 from the current level of around 8,000. But Dow 400. Two zeros. As in: A 95 percent drop that would set the clock back to 1955." But the Internet revolution undermined his credibility.
Still Prechter warned: "The magnitude of the financial calamity that will accompany the bear markets in stocks, bonds and the economy will dwarf any difficulties this country has experienced." Yet nobody was listening. America had fallen in love with the Nasdaq, online trading and triple-digit returns.
Prechter held firm. While conceding weaknesses in his timing, he told Mutual Funds magazine that he merely "cried wolf" too soon: "I have been wrongly bearish in the 1990s, unwilling to remain with a crowd I believe is heading toward a cliff like an army of lemmings."
The Net: Delaying doomsday?
Prechter says Internet mania put off his super-bearish scenario, but also added new fuel inflaming cultural tensions that guaranteed the onset of a 100-year depression.
In 1999 Prechter published a new book: "The Wave Principle of Human Social Behavior and the New Science of Socionomics." He summarized his behavioral finance theories this way in his Sept. 11 newsletter: "Markets are driven by natural trends in mass psychology, and events resulting from those psychological trends come afterward." Cultural conflicts would inevitably trigger a global financial collapse.
So Sept. 11 got me thinking about Prechter again: Was he was right in 1995? Just a misunderstood prophet, a few years ahead of his time?
Today, as the shock wears off, I'm again discounting Prechter's doomsday scenario. Yes, another long cultural struggle has emerged between good and evil. But I see the positive side now: The good guys will win. Even more significantly, we'll see a coming together of people everywhere, creating a new world community.
Fear vs. faith
Still, we can't dismiss the near-term bearish environment. So what's the best strategy? Here are two possibilities, one from Prechter. The other from Larry Swedroe, author of "What Wall Street Doesn't Want You to Know: How You Can Build Real Wealth Investing in Index Funds." Swedroe's a money manager with an interesting new book coming out next year called "Rational Investing for Irrational Times," all about wealth building in bear markets.
Prechter's is more for short-term day-traders based on fear, while Swedroe's is more for the long-term passive investor. Prechter summarized his 11 "Bear Market Strategies" in a January newsletter:
Don't go long in stocks or mutual funds.
Park your money Treasurys and money markets.
Short the market with an inverse index fund like Bear ProFund (BRPIX: news, msgs)
Or an actively managed short fund like Prudent Bear (BEARX: news, msgs)
Use a "safe bank," and expect a run on the national banking system.
Wealthy individuals should invest in the "very safest institutions in the world outside the U.S."
Avoid investment real estate. Your home is a "consumption item" not an investment.
Cash out whole life policies, use term life, anticipating insurance company investments will fail.
Look into professionally managed hedge funds shorting over-priced stocks.
Consider a market-neutral strategy because they averaged returns of at least 25 percent for 2000 (vs. less than 10 percent for the S&P 500.
Consider long-term equity anticipation securities, "leaps," stock options that expire in 2 to 5 years rather than the typical one year.
Does it work? Hulbert Financial Digest tracks the performance of financial newsletters. Mark Hulbert says: "From 1985 through last September, "an investor who switched between hypothetical shares of the Wilshire 5000 and T-bills on Prechter's timing signals for traders would have produced a 21.3 percent annualized LOSS, in contrast to 13.7 percent for buying and holding."
Alternative buy 'n' hold portfolio
Indexing guru Swedroe also dismisses Prechter's fear-based predictions. Swedroe's alternative portfolio uses low-cost, no-load index funds (Vanguard, DFA or IShares), with 70 percent in domestic, 30 percent in foreign stock funds. Here are his recommended indexes, along with the Vanguard fund tickers:
14 percent Wilshire 5000 (VTSMX: news, msgs)
14 percent S&P Mid Cap 400 (VIMSX: news, msgs)
14 percent Russell 2000 (NAESX: news, msgs)
14 percent S&P 600/BARRA Small Cap Value (VISVX: news, msgs)
14 percent Morgan Stanley REIT Index (VGSIX: news, msgs)
10 percent MSCI European Index (VEURX: news, msgs)
10 percent MSCI Pacific Free Index (VPACX: news, msgs)
10 percent Select Emerging Markets Free Index (VEIEX: news, msgs)
Guess what: Swedroe's basic bear market portfolio would also work in a long-term bull market. And that realization, folks, revived my faith.
Yes, the impact of 9/11 is still with me. But gone is the feeling that maybe Prechter's right about a 100-year depression. My faith in the good guys always winning is back.
Still, I owe the super bear and his doomsday scenario a debt of gratitude for helping me work back to my optimism in the future of the market, economy and the world.
-- posted by KLR
» Rande - Opinions are like b.
Opinions are like b....ellybuttons, everybody has one.
For those who prefer the facts...
Financial research firm DALBAR (www.dalbar.com) did some number crunching and here's what they found:
From January 1984 through December 2000 --
* The average fixed-income investor realized an annualized return of 6.08% vs. 11.8% for the long-term Government Bond Index.
* The average equity fund investor realized an anualized return of 5.32% vs. 16.29% for the S&P 500 Index.
* The average money-market fund investor realized an annualized return of 2.29% vs. 5.82% for T-bills.
Why do we do this to ourselves?
-- posted by Rande
» MarketProfit - Only attempt to time the market if you are a saaaaavy market pro
Only attempt to time the market if you are a saaaaavy market profit!-- posted by MarketProfit
» Kirk - Dreman saying not to time the market
Forget about running to cashGood article in Forbes on this
http://www.forbes.com/global/2001/1126/0...
Exerpt:
Fleeing stocks is the predictable response to disturbing news, but is almost always the wrong move. You have about as much chance of timing the bottom as buying a winning lottery ticket. Markets shoot up when least expected, often sharply.
Beware of fixed-income creep. Many investors throw out their portfolios' long-term-equity-to-fixed-income ratios as the equity portion declines. This is precisely when they should be restoring the balance to their portfolios.
Such a step should allow you to make up the damage from a bear market more quickly when the market turns. Let's say that your normal portfolio structure is 65% stocks and 35% bonds and cash and that it has fallen to 50% equity or lower. Bring the equity portion back to 65% by reducing your cash or selling some of your longer-maturity bonds. I would sell further-out maturities because interest rates now are well below their norms and are likely to rise as the U.S. economy begins to recover. Even a one-point rise in interest rates on a 20-year U.S. Treasury can cost you 11% of your investment.
-- posted by Kirk
» Rande - "It doesn't work.
"It doesn't work...."The Washington Post, November 11, 2001
International Herald Tribune, November 12, 2001
The Trouble With 'Timing’: It Doesn't Work, by James K. Glassman
IN THE STOCK MARKET (as in much of life), the beginning of wisdom is admitting your ignorance. One of the many things you cannot know about stocks is exactly when they will up or go down. Over the long term, stocks generally rise at a nice pace. History shows they double in value every seven years or so. But in the short term, stocks are just plain wild. Over periods of days, weeks and months, no one has any idea what they will do.
Still, nearly all investors think they are smart enough to divine such short-term movements. This hubris frequently gets them into trouble. For example, many investors, believing that the economy would collapse after the Sept. 11 terror attacks, sold their shares at the first opportunity. The Investment Company Institute reported that investors pulled $29.5 billion out of stock mutual funds in September -- the largest one-month withdrawal in history. General Electric Co. fell below $30 a share, and Oracle Corp. dropped to $10. The Dow Jones industrial average skidded to 8,236 points; the tech-heavy Nasdaq composite index, to 1,423.
But within seven weeks, GE had risen above $40, and Oracle broke $16; the Dow was above 9,500 and the Nasdaq above 1,800. Investors who sold their stocks in late September in anticipation of hard times ahead got a rude surprise. But, as surprises in the market go, it was a pretty common one. The strategy that these investors were employing -- trying to make money by predicting stocks' short-term moves -- is called market timing. It doesn't work. Period.
The reason for the failure of market timing can be summed up in two words: "random walk." That phrase, made popular 30 years ago by Burton Malkiel, an economist at Princeton, describes the pattern that stock prices take in the short term. It's random. You can't guess it; no one can.
Mr. Malkiel's notion was that a stock price is determined by everything that millions of buyers and sellers of stocks know about those stocks today. Its price tomorrow is unknowable today because it is determined by the events of tomorrow. So, from the current perspective, the future price looks random. For example, investors who want to sell because they see an economic downturn ahead do not seem to realize that they are not alone. Other investors, also seeing such a downturn, have already priced stocks for that negative event. The stock price is "discounted" (as the jargon goes) to take the expected hard times into account.
This idea is at the heart of what is called the "efficient market theory" -- which, taken to its logical extreme, concludes that every stock is perfectly priced; that is, the market doesn't make mistakes. Clearly, the market does make mistakes. Investors get hyperexcited about something and bid it up into the stratosphere, or they get overly depressed about something and drive it deep into the ground. But, in general, an individual investor should have a healthy respect for the daily price that all the other investors in the world set for a stock. At any rate, you don't have to believe in perfect markets to believe you cannot guess stock prices from one day to the next. It is impossible to overemphasize this basic truth about investors' own ignorance.
Some analyses may seem to show otherwise. A new study by the Connecticut firm Birinyi Associates, cited in a recent Barron's article, finds that investors who are out of the market during the five worst days each year do astronomically better than who hold their stocks throughout each year. For example, in 2000, the Standard & Poor's 500 index dropped 10 percent (not including dividends), but an investor who invested in the S&P every day but the five worst made a profit of 9 percent. In 1998, being out of the market during the five worst days would have given you a return of 56 percent instead of 27 percent. Overall, a dollar invested in the S&P stocks in 1966 became $12 for the buy-and-hold investor (again, without dividends) but an incredible $987 for the investor who missed the five worst days each year.
But this conclusion begs an important question: How can you know when to stay out?
You can't.
It's no secret that the market moves in spurts, both up and down. If you miss the five best days each year, your returns are vastly reduced. Stocks are highly volatile in the short run.
The Barron's article quotes the self-described market-timing advocate Bob Brinker as saying that the Birinyi study had confirmed his own approach. Mr. Brinker told his readers to switch their portfolios in January 2000 from 100 percent stocks to just 40 percent stocks, saying, "I think the probabilities are we've entered a secular bear market."
That was a good call, no doubt. But Mr. Brinker missed the huge run-up since Sept. 21, and, more important, his long-term record is nothing spectacular. According to Hulbert Financial Digest, for the 10 years through Dec. 31, 2000, Mr. Brinker's long-term growth portfolio rose an annual average of 13.7 percent, while the S&P rose at 15.1 percent. I will not deny that Mr. Brinker is good compared with other timers, but why go to the trouble of jumping in and out of the market if you cannot beat the averages?
The Hulbert newsletter, the authoritative record-keeper, recently looked at the top 10 performing newsletters (nearly all of which employ timing, of one sort or another) during October 1987, a month in which the market lost worse than it did in September 2001. Mark Hulbert, the editor, then asked, How have these market timers done since? The answer: rotten. If you had followed these newsletters, moving in and out of stocks and mutual funds as they suggested, you would have achieved an average annual return of just 4.5 percent between November 1987 and September 2001.
"You could have made more than that just by investing in 90-day Treasury bills," Mr. Hulbert wrote.
The market as a whole returned 12.9 percent nearly triple the rate of the timers. What is the alternative to timing? It is finding good stocks and mutual funds at reasonable prices and buying them with the intention of holding them for a long time meaning five years or more. Sell only if something has happened to the underlying company (its management, products, competitive position), not to its stock price. While market timing is bunk, there are better and worse times to be buying individual stocks. Last month, for example, David Anders of Merrill Lynch & Co. reported that gaming stocks appeared to be particularly well priced. In a careful analysis, he showed that the cash that casino companies -- including Harrah's Entertainment Inc., Mandalay Resort Group, MGM Mirage and Park Place Entertainment Corp. -- are likely to be earning over the next few years justifies considerably higher stock prices. Casino stocks were driven down sharply by the attacks of Sept. 11. They have bounced back since the Anders report but remain -- at least by his lights -- "compelling values." I cite gaming stocks not because they're guaranteed winners but because they are the kind of potential bargains you should spend your time and energy pursuing. Forget about timing the market; concentrate on buying good companies.
James K. Glassman is a fellow at the American Enterprise Institute and serves as a consultant to Folio Investing (www.foliofn.com). He invites comments at jglassman@aei.org, but he cannot answer all queries. Of the stocks mentioned in this column, he owns General Electric.
-- posted by Rande
» Rande - Re: Re: "It doesn't work.
In response to message posted by SteveT:
That's a sucker bet, Steve. I'll bet Kirk likes this line, though:
Forget about timing the market; concentrate on buying good companies.
Here's my favorite:
At any rate, you don't have to believe in perfect markets to believe you cannot guess stock prices from one day to the next. It is impossible to overemphasize this basic truth about investors' own ignorance.
-- posted by Rande
» R_Lewis - "Shocking stat"
"A shocking stat: If funds were only invested in equities from early November to early May of the last 20 years, returns would have totaled 952 percent, almost double the return from being invested for equities for the entire year [505 percent]""says Merrill in a report entitled "Seasonal Stuffing" "What was that about timing again?"---Fortune.com
Richard
-- posted by R_Lewis
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