Market Timing: Should You Attempt It?

Top 70. Jun 12, 2001 6:50 PM

» JIMMY62 - Re: Re: Profit Taking

In response to message posted by Kirk:

I just gave you a REAL example of where I sold about 15% of my position in an equity that had appreciated 64% while "the market" was virtually flat.

How is that market timing? The MARKET had nothing to do with my sale as it was flat (virtually).

It was not market timing, yet the MARKET did have something to do with the sale. If the MARKET had gone up 64% there would have been no sale.

Due to the price runup while the balance of the market was flat, your holdings of the security reached a percentage of your portfolio that is no longer comfortable; violated some rule of thumb.

One plausible implication is There's a better investment alternative. But a specific investment alternative was not part of the decision, so that was not the controlling reason for the sale.

You did not says that You need the cash., so that reason can be discarded.

The controlling reason for the sale was not even profit taking even though it is characterized as such. It was portfolio balancing; a form of risk management that is supported by a lot of theory.

-- posted by JIMMY62

Top 71. Jun 12, 2001 7:10 PM

» Rande - Re: Re: Re: Profit Taking

In response to message posted by JIMMY62:

I would classify rebalancing under "better alternative investment," as broad as that definition might be. For the investor who follows a disciplined long-term strategic asset allocation approach, rebalancing from an overweighted asset class to an underweighted asset class represents selling an investment for a better alternative. That may seem like a stretch, since the reason the alternative investment is better is not directly tied to market timing or fundamental analysis or any expectation about the future relative performance of one investment over another. But it still fits my own basic philosophy that there are only two reasons for ever selling:

1. There is a better alternative (for whatever reason)

2. You need the cash.

BTW -- The real debate is over #1 and how you can possibly tell what a better alternative might be. Could be you've hit your price target, or hit your stop loss, or the fundamentals have changed, or if it's a fund the manager has changed, or you follow the charts and don't like what you see. Then there are the market timers who feel it's possible to predict the movement of broad asset classes and the market as a whole, as ludicrous as that seems. While some of these reaons/approaches may prove more satisfactory than others, ultimately all are lacking. Since there is really no way to be sure that an alternative investment will really prove "better" than the one you are selling, a strategic asset allocation approach grounded in long-term patience and discipline is the best approach over long periods of time. If your equity weighting becomes too large relative to your bond weighting, then there is a "better alternative" -- you sell some equities and buy some bonds. Works the other way too. Let the market itself decide for you when it's time to sell high and buy low, without regard to emotion or a misplaced belief that you're somehow smarter than the market itself based on whatever active system you might be tempted to employ.

-- posted by Rande

Top 72. Jun 12, 2001 7:40 PM

» JIMMY62 - Re: Re: Re: Re: Profit Taking

In response to message posted by Rande:

Right, I had the point you make nagging at the back of my mind even as I posted. Lowering the risk level is a form of "better alternative."

The first understanding of "better alternative" is probably higher return. The objective of portfolio balancing is not higher return, it is lower risk. In fact, any top down analysis will show that the people who have made the greatest return in security investing have held the same security forever. The people who lost everything by holding the same security forever don't get the same coverage in books and research papers.

My quibble is with characterizing portfolio balancing as "profit taking" and the statement that the MARKET had no bearing on the sell decision when juxtaposed with the data on percent of the portfolio the security made up. Suppose that the MARKET had not been flat, but fell dramatically, while the price of the security in question remained flat. A similar portfolio distortion would appear. How could selling a security whose price had not moved so as to balance the portfolio be characterized as "profit taking?"

As far as market timing is concerned, I am fascinated by the concept and convinced that it can be done. Not everywhere and at all times, but enough to be useful and profitable. I am convinced of the value of security analysis; not the drum beat of buy signals emitted from the tv shows, but data mixed with opinions can help; there are "fat pitches."

-- posted by JIMMY62

Top 73. Jun 12, 2001 8:02 PM

» Kirk - Re: Profit Taking

In response to message posted by JIMMY62:

Interesting comments.

The objective of portfolio balancing is not higher return, it is lower risk.

I recently wrote (not yet published) that one reason to take profits again was the security was now 15% of the portfolio and it has a risk of falling in half and I want to limit my downside to that security to 5% portfolio loss, just as you said.

One of my "techniques" if you want to call it that is to buy VERY GOOD companies that are volatile. It allows me to buy low and sell high many times as I might say "I want no more than 20% of my portfolio in that industry". Since the Beta for these securities is very high and movement often leads the overall market movement by many months, it makes for some interesting opportunities.

For the name "profit taking", I might just call it something else when and if I decide to sell...

-- posted by Kirk

http://cbs.marketwatch.com/news/story.as...

Top 74. Jun 18, 2001 6:59 AM

» Rande - Worlds Apart?

Worlds Apart?

Timers from Mars, buy'n'hold from Venus

Which strategy wins in Zeus' capricious market?

by Paul Farrell at CBSM

[Conclusion: As bad as market timing might be, even bad market timing can be better than never investing at all.]

LOS ANGELES (CBS.MW) - Recently an extremely critical email arrived from a "successful market-timer" who claims that he was fortunate enough to get out of tech funds before last year's crash. Using timing tools to make sell decisions, he generated a 20 percent return in 2000 while the market was way down. And like many macho timers, he trashes buy-and-hold investing.

Which is better? Market timing or a long-term buy'n'hold strategy? More specifically: Could market-timing work for all 83 million investors in America? We know there are successful traders in America, maybe 250,000 in total. But will the strategy and mindset that makes them successful work for the other 82,750,000 investors?

Aliens millions of miles apart

Market-timers are from Mars. Buy-and-hold investors are from Venus. They speak different languages. Not only don't they misunderstand and fail to communicate, they can get very intolerant of their differences, especially those aggressive macho Martians. Indeed, the very term "market-timing" conjures vastly different set of psychological emotions for short-term timer-traders versus long-term investors. Listen:

FAITH in "market-timing" lures short-term traders into trading. Traders use market-timing skills and tools to stay in the market. They believe they can "beat The Street," do better than buy'n'hold investors because they have some unique gift as a market-timer, a power to outsmart the masses.

FEAR of "market-timing" keeps long-term investors out of trading. On the other hand, a long-term buy'n'hold investor uses fear of market-timing for just the opposite reason -- to stay out of the market, permanently and temporarily. Fear of making mistakes and losing money keeps them out the market.

Traders have an inherent "faith" in market timing. They believe deep in their souls that market-timing is a tool which is virtually guaranteed to help them beat the market. And they need to prove they are winners, to build up their egos, to enhance their sense of self-worth.

Both timers and investors are handicapped

On the other hand, long-term investors react quite the opposite. Investors have an emotional "fear" of market timing. Markets are capricious and unpredictable. They don't have time to master esoteric trading systems. They just don't trust timing. Oddly, this same fear is why, in part, only half of all Americans own securities, and two thirds aren't saving enough for retirement. Fear of making mistakes results in paralysis.

Note, however, the paradox. They are handicapped by their own strategies: Both the trader's strong "faith" in market-timing, and the investor's "fear" of market-timing, work against each of them:

Excessive over-active trading actually reduces returns.

While excessive fear of markets results in nothing invested.

The fact is, traders could use a bit more healthy skepticism toward market-timing. And investors might learn to accept that sometimes market-timing can be a powerful ally. Let's look at both sides of this psychological controversy.

Mars: the more you trade, the less you earn

Two behavioral finance professors at UC Davis, Terry Odean and Brad Barber, concluded that "the more you trade, the less you earn." They studied the results of 66,400 investors over a six-year period. Conclusion: The most-active traders turned over their portfolios 258 percent for an 11.4 percent return. While the least active generated 18.5 percent returns on 2 percent turnover.

Passive investors make 7.1 percent more than the most-active traders. Yet not unexpectedly, the increased odds become an even bigger challenge to macho traders who are convinced they can beat the market.

"You just don't understand me!"

Regardless of the motivation, there are 250,000 Martian short-term timers out there who just don't understand those 82,750,000 passive Venusian long-term investors. And they never will - aggressive timers are from Mars, buy'n'holders are from Venus. Accept it, they're from different planets psychologically. They can't communicate. However, before you make up your mind where you are, here are some more facts and psychological factors to consider:

Investors buy at the top, sell at the bottom. Morningstar research concludes that fund investors tend to buy and sell at the wrong time. Buying on euphoria at a peak. Holding too long then panic selling at bottoms. Either way, the pattern spells losses for most investors. The fact is, emotions are likely to mislead the buy-sell decisions of 82,750,000 American investors.

Wall Street uses these behaviors against investors. Mutual fund genius Sir John Templeton tells us Wall Street uses the emotions of the average Main Street investor against them: "Outperforming the majority of investors requires doing what they are not doing. Buy when pessimism is at its maximum, sell when optimism is at its maximum." In short, pros know how to take advantage to the emotions of the masses.

Many "successful traders" aren't successful. Behavioral finance studies show 88 percent of investors are caught in a self-deceptive trap called "optimism bias." They believe - and need you to believe - that they are "winners." Yet, over half who thought they were beating the market actually finished anywhere between 5 to 15 percent or more under the S&P 500.

But there's another side to the coin - all too many investors let their "over-active fear" of timing keep them out of the market, endangering their financial health, often as much as those alien-traders with too much aggressive Martian faith in market-timing.

Venusian: "bad timing is better than nothing!"

The Schwab Center for Investment Research examined the four hypothetical investors, each with a different investment strategy. Four buy'n'hold investors each get $2,000 annually for 20 years, a cumulative total of $40,000. Here's how their strategies worked out, and the value of their portfolios after two decades:

The Perfect Timer - $387,120. This one puts the money in the market at the monthly low-point every year, perfectly timing the market for twenty years.

No-brainer - $362,185. This one automatically invests money on the day received. A no-brainer, with no timing, just dollar-cost averaging according to an automatic saving plan.

Bad Timer - $321,569. Just the opposite of The Perfect Timer, this poor soul buys at the worst time every year, at the peak of the market, for 20 years.

Never-buys-stocks - $76,558. Fear controls, fear of the market, especially stocks. The money goes in safe T-bills, year-after-year, fearful the market is going lower.

The conclusion is a very simple. Use the no-brainer strategy, invest up their money immediately and automatically regardless of market conditions, and without "thinking" about it. You'll even beat the "bad-timer." But remember also, even a "bad-timer" beats a "no-timer" who never gets into the stock market. They lose almost a quarter million dollars.

Neither Mars or Venus can beat Zeus

Frankly, over the years the evidence has convinced me that timing is best left to those 250,000 odd looking aliens from Mars. The 82,750,000 passive buy'n'hold investors from Venus just don't have the psychological mindset to ever comprehend what makes Martians so convinced that they can outwit the capricious, unpredictable master of the universe, Zeus - who loves to humble the macho!

-- posted by Rande

Top 75. Jun 18, 2001 11:02 AM

» DennisL - Re: Worlds Apart?

In response to message posted by Rande:

Great article, Rande. Thanks for posting it. After reading it, I'm even happier to be from Venus than I was before...8-)

-- posted by DennisL

Top 76. Jun 18, 2001 11:15 AM

» Rande - Re: Re: Worlds Apart?

In response to message posted by DennisL:

Dennis,

Yeah, it's a good one. I like Farrell's "Mars and Venus" twist. Had to chuckle at the opening parapgraph where he mentions he received an "extremely critical email... from a 'successful market-timer' who... like many macho timers... trashes buy-and-hold investing."

Boy, does that ever sound familiar. smile

-- posted by Rande

Top 77. Jul 6, 2001 7:07 AM

» Rande - Interesting update (back during the March depths) from those &#8

Interesting update (back during the March depths) from those “Dow 36,000” guys:

Sunday Business (London), March 25, 2001

Stocks Are Still a Good Buy and Dow May Still Reach 36,000, Brits Say

Members of the US Federal Reserve's Open Market Committee met last week to discuss interest-rate policy, but it's a good bet they talked about the stock market, too. Everyone else is. Amid all the blather about how the "bull market has ended" and the "bubble has burst", it's useful to step back and put the recent swings in perspective.

On 5 December 1996, with the Dow at 6437 and the S&P 500 index at 744, Fed chairman Alan Greenspan issued his famous warning about "irrational exuberance" -- shortly after he had heard an admonition from Yale University economist Robert Shiller that stocks were on the verge of falling by half or more. It's easy to see why concerns about a market bubble were prevalent. The S&P 500 had risen 61 percent since the end of 1994 and confident individual investors were pouring money into equity mutual funds.

The analysis, which called for a crash or a severe correction, was based on what was then a widely accepted view of stock valuation -- the notion that there are specific ceilings to price/earnings ratios (the consensus was around 15) and floors to dividend yields (around 3 percent ). Beyond those limits, stocks were supposed to correct sharply. This view did not prove useful over the subsequent four years. The p/e of the Dow never fell below 15 after 1991. The dividend yield went below 3 percent in 1993 and never looked back.

Far from crashing or even declining, the market continued to surge after 1996. If you had put money in the S&P 500 index the morning after the speech, and kept it there until today, your account would have increased at an annual rate of 13 percent , nicely above the historical average.

But the increase was not steady. It never is. After posting gains of more than 20 percent in 1998 and 1999, the Dow fell 5 percent last year and, so far in 2001, it has dropped another 8 percent . The S&P 500 has fallen 11 percent this year; the Nasdaq, 21 percent . While the bears were wrong in their 1996 forecast, a reasonable question is whether US stocks will continue to fall from here on out. Or, to put it in more personal terms, will our own bullish analysis, first expressed in the Wall Street Journal on 31 March 1998, and then in our 1999 book, Dow 36,000, prove inaccurate?

The way to approach this is to ask: what's changed? This is the same question any investor should ask about his portfolio after a sharp decline in stock prices. If nothing has changed, stick to the strategy. Specifically, we believe rising prices depend on two factors: the fundamentals of US corporations and the US economy, and the continued desire of investors to hold stocks. Let's look at each.

Business earnings and cash flow are closely correlated with the economy. When Greenspan first gave his warning about exuberance, government agencies thought the speed limit for the US economy was about 2 percent annual growth in gross domestic product. Growth beyond that level, it was widely believed, would ignite inflation and a quick Fed response. This speed limit also applied to corporate earnings, since average earnings, in the long run, could not be expected to grow faster than the economy.

But since 1996, government agencies have consistently revised those projections upward. On 31 January, the Congressional Budget Office forecast for the decade ahead was 3 percent annual growth -- below the consensus of most business economists, at 3.3 percent , but half-again as high as the office's long-term projection in 1996.

Of course, the recent forecasts are just that. But, with the rise in productivity in the US over the past five years -- and its persistence even as the economy slowed in the fourth quarter of 2000 -- there are strong reasons to believe long-term economic prospects have improved. Moreover, the good news about growth affected the bottom line. Corporate profits between 1996 and the end of 2000 rose at about double the historical average. Thus, a healthy upward movement in stock prices from the level of 1996 seems warranted -- as do increases from today's level.

This is not to say there are no threats. For example, the trip-ling of oil prices and the Fed's misjudgment in delaying rate cuts last autumn have slowed the economy sharply and profits have gone along for the ride.

Stocks nearly always drop when the economy slows and corporate profits fall, and the decline has nothing to do with bubbles. Volatility is the very nature of the equity market in the short term -- which is the reason that pessimists, like stopped clocks, will occasionally seem right. The key is the long-run ability of the economy to grow. If anything, these prospects are better now than they were in 1996 and in 1998, when we used an annual GDP growth rate of 2.5 percent as our assumption for Dow 36,000.

The second key factor behind rising equity prices is that investor sentiment does not turn sharply against stocks and stay there. This notion has been put to the test lately. Certainly, investors will act on their fears in the short term, but in the long term we believe the facts will prevail.

Recall that for most investors the choice is between stocks and fixed-income assets. Will they increase their demand for bonds at the expense of stocks? The data suggest such a move would be highly unprofitable and investors know it. The broadly diversified US market, with the S&P 500 as the recent proxy, has returned an annual average of 12 percent since 1926. Investors, then, can reasonably expect to double their money every six years, quadruple it every 12, octuple it every 18. No guarantees, of course, but there's a powerful body of data and logic behind such a forecast.

As for the alternative, bonds, they have a fairly abysmal long-term record and less-than-stellar short-term record as well. Last year, the yield for a typical short-term bond fund was about 6 percent . A US taxpayer in the top tax bracket kept about 3 percent of that after taxes. Inflation was 3.4 percent last year, so the after-tax real return last year was, for many investors, negative. Over the past five years, the typical intermediate bond fund gave investors a similar performance. Sound enticing?

Still, there's little doubt that many investors and institutions are attracted to an alternative investment strategy proposed by bears -- moving back and forth between stocks and bonds depending on the level of the market. Adherents of this view often point to a chart that shows that the market generally underperforms when the p/e ratio is high. Investors, the story goes, are foolish if they purchase stocks today because they are ignoring the long-run relationship between p/e ratios and future returns.

Another phrase for such activity is market timing and, in real life, it doesn't work, period. As John Bogle, the founder of Vanguard mutual funds, put it: "After nearly 50 years in this business, I do not know of anybody who has done it successfully and consistently. I do not even know anybody who knows anybody who has done it successfully and consistently."

As we highlighted earlier, the p/e alarm that sounded in 1996 (and, in fact, began ringing in 1991) did not correctly signal lower future returns. Even after the decline of the past year, a simple S&P index fund would have returned 94 percent during the past five years.

What about the longer term? Using S&P data, we compared a simple buy-and-hold strategy with one of buying stocks only when the p/e of the market is under the historical average and shifting to bonds when the p/e rises above that figure. For example, in 1946 our hypothetical investor would compare the p/e to the average through 1945 (14) and then decide whether to own stocks or bonds.

The result? The buy-and-hold strategy beat the p/e market-timing strategy, after taxes, by about 1,000 percent between 1946 and 2000. Will investors collectively accept a view that is obviously false? Not for long.

So let's look at history one more time. If you put $2,000 in the US market in 1950 and let it sit, then today those same stocks would be worth $1.2 million. If you put $2,000 in US government bonds in 1950, today you would have $25,000. With such a difference, does what happened in 1949 matter?

When criticised for revising his position, John Maynard Keynes once replied: "When the facts change, I change my mind. And what do you do, sir?" That's a rare philosophy these days and one we admire. So we checked the facts. Stocks are still a good buy. Our position hasn't changed.

-- posted by Rande

Top 78. Jul 6, 2001 8:17 AM

» Mark_J - Re: Interesting update (back during the March depths) from those

In response to message posted by Rande:

Good article, Rande. Hard to see one item such as "PE multiples" being a trigger for an all-or-nothing market timing strategy.

Reminds me of a book I read in the late 80's, by Charles Givens called "Wealth Without Risk." I think there were updates to that book over the years. But in the first one, he had developed a stock market timing strategy that was based solely on the Fed and interest rates. My guess is that this specific model he detailed was removed and changed for subsequent editions...

-- posted by Mark_J