market timing

[9/14/14] Extensive data over multiple years shows that market timing as an investment strategy does not work.

The base case for the market over a long period of time is to move upward. Historically, the stock market advances at an annual rate of around 6% above the risk-free rate. With the risk-free rate around zero, this indicates that a 6% annualized rate of return for the market is reasonable at current levels. It is important to note that this rate of return materializes through all sorts of political and economic catastrophes. Look what the U.S. equity market has faced since 1973:

Issues that Menaced the Market

1973: ENERGY CRISIS
1974: NIXON RESIGNS
1975: FALL OF VIETNAM
1976: ECONOMIC RECOVERY SLOWS
1977: MARKET SLUMPS
1978: RISE IN INTEREST RATES
1979: OIL PRICES SURGE TO NEW HEIGHTS
1980: INTEREST RATES AT ALL-TIME HIGHS
1981: BEGINNING OF A SHARPLY RISING RECESSION
1982: UNEMPLOYMENT REACHES THE DOUBLE DIGITS
1983: RECORD BUDGET DEFICIT
1984: TECHNOLOGY BUBBLE BURSTS
1985: EPA INITIATES BAN ON LEADED GASOLINE
1986: DOW AT 1800 - "TOO HIGH"
1987: STOCK MARKET CRASH
1988: WORST DROUGHT IN 50 YEARS
1989: SAVINGS & LOAN SCANDAL
1990: IRAQ INVADES KUWAIT
1991: RECESSION
1992: RECORD BUDGET DEFICIT
1993: CONGRESS PASSED LARGEST TAX INCREASE IN HISTORY
1994: INTEREST RATES ON THE RISE
1995: DOLLAR AT HISTORIC LOWS
1996: GREENSPAN'S "IRRATIONAL EXUBERANCE" SPEECH
1997: COLLAPSE OF THE ASIAN MARKETS
1998: LONG TERM CAPITAL COLLAPSES
1999: Y2K PROBLEM
2000: DOT-COM STOCKS PLUMMET
2001: TERRORISTS ATTACK ON U.S. SOIL
2002: CORPORATE SCANDALS: ENRON
2003: U.S. INVASION OF IRAQ
2004: INFLATED OIL PRICES
2005: TRADE DEFICIT
2006: LEBANON CONFLICT
2007: CREDIT CRUNCH
2008: MASSIVE BANKING  FAILURES, HOME PRICES DOWN
2009: STATES HOVER NEAR BANKRUPTCY
2010: SOVEREIGN DEBT CRISIS
2011: EUROPEAN DEBT CRISIS
2012: FISCAL CLIFF
2013: SYRIAN CRISIS/DEBT CEILING DEBATES

Now imagine that you could have predicted the yearly problems detailed above. Say for argument's sake that you were capable of not only predicting the above events, but also knew exactly when the events were going to occur down to the exact month. What was the correct course of action to take?

In almost every case, the best strategy was to wait for the market to sell-off in response to the event and then buy more equities. When you take the perspective of a true long-term investor, the market movements around the above events are simply small fluctuations.

Of course, there are years and even a decade or two when the market will be full of sound and fury and not advance. In these periods, returns are limited to dividend payments from the stocks owned as prices do absolutely nothing. Also, along the way there are market crashes and corrections.

There has been true fear in the market, and I can guarantee you that at some point in time fear will return. Nevertheless, the key for an investor is to shun both the fear and the greed, and instead try to stay invested over a long period of time.

Look back at the list above. It is very clear that for long-term investors the best action historically has been mostly to:

Ignore the News and Stay Invested.

Make sure the allocation across various investment strategies is consistent with your risk level. This enables you to remain invested even in the face of higher than normal degrees of volatility.

We know that if we go out twenty years, even given current valuation levels, stocks will likely outperform most other asset classes. The basis for that knowledge is that it has been that way historically.

[Mitch Zacks, ZIM Weekly Update]

[11/19/08] Assume, for example, that it is December 31, 1925, and we are consulting a market timer who has made forecasts of 1926 security returns for Treasury Bills, long-term government bonds, long-term corporate bonds, common stocks, and small stocks. He correctly predicts that of these five investment alternatives, common stocks will produce the best total return for 1926. We invest $1.00, which by the end of 1926 grows to be worth $1.12. Impressed with our market timer's predictive abilities, we again meet with him on December 31, 1926 for his advice as to where to position our money for the following year. Year after year our market timer, with perfect predictive accuracy, advises us concerning which investment alternative is appropriate for our market-timed portfolio.

Through compounding our wealth in this manner, our initial $1.00 investment would grow to be worth more than $85 million by the end of 2005. This result is impressive when compared to the best-performing investement alternative, small company stocks, with its ending value of $13,706, and with the more modest ending value of approximately $18 for Treasury Bills!

To contextualize this phenomenal result, consider the outcome had we initially invested $1 million with our market timer at the end of 1925. By the end of 2005, our portfolio would be worth more than $85 trillion. We would own more than 90 percent of the world's total investable capital of $93.4 trillion.

Clearly, such market timing ability does not exist.

... According to a research study by William F. Sharpe, "a manager who attempts to time the market must be right roughly three times out of four, merely to match the overall performance of those competitors who don't. If he is right less often, his relative performance will be inferior. There are two reasons for this. First such a manager will often have his funds in cash equivalents in good market years, sacrificing the higher returns stocks provide in such years. Second, he will incur transaction costs in making switches, many of which will prove to be unprofitable.

[from Asset Allocation by Roger C. Gibson, which was excerpted in What Do I Do with My Money Now? by Clint Willis]

[11/15/08 via chucks_angels] "The long, sad history of market timing is clear: Virtually nobody gets it right even half the time. And the cost of getting it wrong wipes out the occasional gain of getting it right. So the average investor's experience with market timing is costly. Remember, every time you decide to get out of the market (or get in), the investors you buy from and sell to are the best of the big professionals. (Of course, they're not always right, but how confident are you that you will be 'more right' more often than they will be?) What's more, you will incur trading costs or mutual fund sales charges with each move-and, unless you are managing a tax-sheltered retirement account, you will have to pay taxes every time you take a profit." - Charles Ellis, Winning the Loser's Game

[1/27/07] Between 80% and 90% of the returns realized on stocks occurs between 2% and 7% of the time. So, if you're out of the market when stocks make their move, your portfolio is doomed to underperformance.

Between 1986 and 2005, the S&P 500 compounded at an annual rate of return of 11.9% -- even while facing market booms and busts, war, 9/11, constitutional crises, and more. Over that 20-year period, $10,000 invested in the index would have grown to $94,555. Yet a recent report by Dalbar shows that the average investor's return during that time was only 3.9% (so that $10,000 grew to just $21,422). The reason was simple: market timing.

[5/15/06] There are two kinds of technical traders. Some look for signals on individual stocks, jumping from one stock to another, plotting to get in or out ahead of the crowd. Others are like Jim Rohrbach, founder and editor of the investment Web site Investment Models, who employs technical indicators to go in and out of the stock market overall.

"The experts say that the stock market can't be timed," says Rohrbach. "They are wrong."

Buy-and-hold investors, who pay attention to fundamental data ranging from earnings growth and price-earning ratios to book value, always say market timing is a fool's game, doomed to failure. But Stock Trader has profiled other traders such as Tony Carrión, and Frank Minssieux and Serge Dacic, the creators of the Timing Cube system, all of whom excel at and rely on technical analysis.

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[4/20/06] Mike Kavanagh, CFP® asserts that market timing does not work.

"My experience and the following studies show there is no reliable way to time asset classes in the market. This would require a set of crystal balls and tea leaves that simply has never existed and will never exist in my view."

-- from chuck_angels