MARKET TIMING

"Usually, you know a hot sector after the fact, not before."

Marshall Blume, finance professor at the University of Pennsylvania's Wharton School.

(Smart Money) If you could pick the perfect lows of the market to buy and sell at the perfect tops, you could make more money than just a buy and hold. Well, nobody's perfect, but how good would the actual returns be? (Remember you would have to pay taxes on each sale and incur potential brokerage costs as well). The Smart Money example considered just a short time frame- February 1989 to February 1995- but is fairly representative of other studies I have seen. An investor putting in $1,000 in the Russell 3000 index would have received $2,050 under a buy and hold. The market timing expert would have received a lesser amount of $1,950 when taxes were included. Admittedly, retirement accounts such as 401(k)'s do not have any tax implications and one can legitimately accept that market timing would have earned more. But then you would have to be almost perfect. So, are you?

That said however, you still need to recognize rebalancing- the adjustment at least annually for changes in your portfolio due to growth; loss; change of managers, risk,  economics and a host of other factors.That is NOT the same as trying to pick highs and lows but is simply being vigilant of your investments at all times.

MARKET TIMING: 1998 (University of Utah and Duke University) They reviewed 132 newsletter portfolios from 1983 to 1995. The average return was 12% with 11.9% volatility. An S&P portfolio and cash designed for the same volatility returned 16.8% for the same period. Some of the more notable newsletters had the worst performance. Granville Traders Portfolio lost 2.2% annually and the Elliot Wave Theorist Traders portfolio was down 10.1%

MARKET TIMING: According to Terry O'Dean at UC Davis, what appears to be random investor behavior might actually be psychologically mandated. Individuals tend to overweight highly publicized information and under weight regular statistical data. As a result, they are apt to bid up stocks when there is some PR news that seems worthy(?)-however it may take them months to react fully when earnings exceed expectations. This phenomenon is known as post-earnings-announcement drift. The article from Smart Money indicates that investors give routine announcements like earnings relatively little weight and wrongly see any good news as strictly a one-shot affair.

MARKET TIMING: (1999) I receive Emails from a market timing service. I have gotten a lot lately because of the market turbulence. So does it work? Of course- but you have to recognize the limits. For example, the service says that his fund timing selections have beaten the averages- except for the U.S. Well, that's not impressive cause the U.S. is where the bulk of your money should have been. Further, to say you beat the Morgan Stanley EAFE doesn't say that much since almost all analysts would NOT have money in Japan. Lastly, there is always some timing that works for a specified period of time- 1 month, one year and so on. But on an ongoing basis, and certainly when you consider costs and taxes, it is normally a fool's game. Add in all the time you spend trying to outproduce the market and you won't have a life. Remember, the "best" minds in the business had all these hedge funds that the government bailed out. Nobody is going to bail you out.

MARKET TIMING: (1999) There is still an intense fascination with moving in out of the market in an attempt to pick the highs and lows. And those people utilizing 401(k) plans have an added a should since none of the trades are taxable. But does timing the market really work? The Hulbert Financial Digest review 25 newsletters with 32 portfolios and found that none of the newsletter timers beat the market. With a 10 years ending December 31st 1997, market timers averaged from 5.84% to 16.9%-the average being 11.06%. However the S&P 500 index earned 18.06% and the Wilshire 5000 value weighted total return index returned 17.57%. Another ten-year study showed averages from 4.4% to 16.9% a year with the average of 24 market timers at 10.9 %. Even when adjusting for some esoteric risk return average, market timers were still far below the average of the by and hold.

After reviewing extensive reports and articles, the use of market timing might only be viable for tax sheltered accounts-certainly not for core funds that are taxable. Even so, the odds for success for the professional-nevermind the average investor-is so limited and so time-consuming as to be essentially a futile exercise, particularly in a bull market. I would add this cautionary note however that it still does pay to be vigilant. Consider the market around 1974. If one had stayed in, they would've lost or 40%+ of their equity and it would've taken about 12 years in order to break even with a present value investment in treasury instruments. And that case, it certainly would've been worthwhile to a been out of the market for about two years.

In summary therefore, it is best to leave your core funds alone and only adjust in severe economic downturns.

MARKET TIMING: (1999) An Individual Investor article on Market Timing noted that a major timer- Merriman Asset Allocation fund- has returned an average of 10.8% annually for the last three years while the S&P earned 25.4%. Vanguard's funds did 21.4% without timing.

Market Timing: Think Twice Before Trying to Time the Market   (2000)"If there is some consistency in historical equity returns and valuations, the most obvious benefit to the savvy investor would seem to be an ability to time the market. Cochrane analyzes some recent studies dealing with market timing and emerges with healthy skepticism. The fact that the studies necessarily select limited ranges of data leaves their claims of extraordinary market-timing premiums open to suspicion. In the case of a study by Campell and Vicera, which holds that investors should buy into markets with a high dividend/price ratio and sell into markets with a low dividend/price ratio, returns predictability in the 50-year sample were sliced in half by the past two years of low d/p ratios and high returns.

If there were a magical timing solution to the market, one would think that something more than one in four actively managed funds would be able to beat the market. As Cochrane so eloquently puts it "If the strategy is real and implementable, one must argue that funds simply failed to follow it."

Market timing: (Financial Research Corporation 2001): "Our research shows that accelerating redemption rates and declining holding periods are entrenched problems that have been worsening for more than a decade." "It will take a concerted effort by financial professionals and individual investors alike to reverse this disturbing trend and to undo its detrimental affects on the long-term financial health of the investing public."

FRC found that mutual fund investors had 20% lower returns, on average, over 3-year periods during the last decade. In particular, FRC noted that from January 1990 through March 2000, the average fund's 3-year return was 10.92%, while the actual return to investors was 8.7%.

Date	3/31/96	3/31/97	3/31/98	3/31/99	3/31/00
Implied holding period (years)*	5.5	5.0	4.8	3.6	2.9

*Implied holding periods are based on redemption rates. For example, if an investor has a 25% redemption rate, a quarter of assets are redeemed each year, and over a four-year period all assets will be liquidated.
Source: Financial Research Corporation

Fund redemption for individual self-directed investors averaged 18% in 1996 and moved up to 30.5% in 2000. Redemption rates for investors who purchased "wholesale" funds through advisors was 13.8% in 1996 and 25.4% in 2000.

FRC found that investors truly do chase hot-performing funds and sectors - and usually jump on the bandwagon after funds have peaked. Over the 1990s, FRC concluded that, on average, $91 billion in new cash flowed into funds after they experienced their best-performing quarters. Conversely, $6.5 billion in new cash went into funds after they had their worst-performing quarters.

Market Timing: (2001) "Isn’t it funny how the things you want to be predictable about investments (like stock prices) aren’t, and the things that end up hurting you the most are? One of the most predictable aspects of the investment business is the plethora of positive “new era” articles that are written during extreme stock market rises and pessimistic “doom and gloom” articles written during market declines. In both cases, writers tend to use very selective statistical “evidence” to enhance their arguments. The predictable downside is that investors by the droves fall for these apparently logical arguments, and their natural tendency to market-time kicks in. The results are almost always disastrous financially and psychologically for the investor. "

Market Risk and Time by Morningstar. An interesting chart that shows how investment risk declines as stocks are held for longer periods of time. For example, the best return on stocks for one year is listed as +53.9 % while the worst return is -43.3 %. However the best and worst returns over a 25-year period are less variable at +14.7 % and + 5.9 %. After reviewing the chart, what implications can you draw about market timing as a portfolio management strategy.

Fund Timing is Dangerous  (Morningstar 2002) Numerous studies have shown that the more an individual investor trades, the worse he or she does. But what about specifically in a bear market?

Buy and Hold????:(WSJ, Barron's 2002) "The buy-and-hold mantra that was drilled into investors' psyches by the bull market of the '80s and '90s no longer leads to nirvana."

The buy-and-hold philosophy also argues that stocks go up over time. According to data from Chicago-based Ibbotson Associates, from 1926 to 1999, 90% of five-year periods were positive for stocks. But those figures don't reveal long periods of pain in the stock market. After the 1929 crash, the Dow Jones Industrial Average took 25 years to regain its pre-crash levels. The Dow traded above 1000 in 1968, but failed to close above that level again until 1984.

Individuals who have steadfastly bought and held this market right down into the sub-basement (think dollar-cost averaging and auto-investing -- the ultimate tricks of the buy-and-hold trade), may finally be realizing that they're the last ones holding the bag.

For stock investors, buying and holding makes little sense, since companies and trends change over time. A stronger case can be made for buying and holding an array of diversified mutual funds, especially since fund managers are not likely buying and holding forever but are continually monitoring and updating their holdings. The idea is that you minimize the risk of staying in the game by spreading your assets among a number of investments.

But even with funds, buying and holding is no elixir. You could buy and hold the life out of an Internet fund, but that won't make it come back to life. And with many folks talking about a lengthy weakness in technology, does it make sense to buy-and-hold tech funds, or "diversified" (read: tech-heavy) funds for that matter?

"The fact is, buy-and-hold is not that easy a system. The reality is there are far fewer companies that are buy-and-holdable than there are publicly traded securities."

Like many of the shortcuts we took during the bubble era, buy-and-hold is actually a rather evil truncation of an intelligent investment strategy."

I do not like nor utilize market timing. But when you read, you become aware of 1973/1974 where there were losses of over 45% in less than two years. Do you wanna do a buy and hold?

Look at last year. Admittedly I wasn't perfect but I got almost everyone out of the majority of equities two weeks before 9/11 and I haven't pursued equities since then- just primarily short medium term bonds. Buy and hold can be a testament to everything wrong economically

"Market Timing (Marc Hulbert) A portfolio that strictly adhered to its investment policy would have produced an annualized return of 5.9 percent from the beginning of 1988 through February this year. In comparison, the newsletter's growth portfolio actually produced an annualized return of 3.3 percent over the period. That means that the newsletter's market-timing decisions and recommended mutual funds cost the portfolio an average of 2.6 percentage points a year.

To track changes in the relative importance of the asset allocation decision, I calculated each newsletter's trailing 10-year returns for every month beginning December 1997, then averaged them. The average newsletter appeared to be doing a slightly better job now than in 1997 but not good enough to justify a shift from strict adherence to an investment policy.

Over the 10 years through December 1997, the combined effect of market timing and choices of actively managed funds reduced the average newsletter's performance 3 percentage points a year. Over the 10 years through February this year, that combined cost was 2.1 points a year.

A similar conclusion emerges from measuring the portion of newsletters that are improving their investment returns through market timing and fund selection. For the most recent 10-year period, 40 percent of them did so, versus 23 percent for the decade through 1997. Still, more than half the newsletters would have made more money over the last 10 years by never deviating from their investment policies.

The unmistakable conclusion is that even in a bear market, market timing and actively managed mutual funds generally hurt investment performance more than they help it."

Market Timing: (St. Petersburg Times 2003) Timers use some type of mechanical model, using computer software to crunch numbers such as interest rates and investor sentiment. The indicators that are fed into the formulas tend to be similar from one model to another, but they may be weighted and analyzed differently. What the timers are looking for is a reversal of trend, an early warning signal to switch from buy to sell or vice versa. Some will act immediately on that signal, while others will wait to see if it is confirmed by subsequent trading days or weeks. They're trying to avoid "whiplash." Jumping in before a trend is firmly establish may mean having to jump right back out again.

The result is that timers are rarely if ever unanimous in their opinions about what the market will do next

 Dalbar recently released its Quantitative Analysis of Investor Behavior study for 2003, which shows that the average investor stayed invested in equity or fixed income funds for less than three years, buying when stocks or bonds went up and selling when the going got tough. In fact, investor retention is at its lowest level since 1988.

The end result is that equity fund investors have earned an average of 2.57% over the past 19 years, a hair below inflation of 3.14%, and far short of the 12.2% annual gain on the S&P 500 for the same period. Fixed-income investors did a little better, with average returns of 4.24%. But that's still well below the long-term government bond index's annualized return over the past 19 years of 11.7%. (Dalbar based its research on monthly cash flows, retention rates, and trade volumes for mutual funds.)

I don't necessarily read market timing newsletters for any great insight, but this was notable: "The interesting thing here, with the market just over the bottom of the recent trading range, is that the factors that had me feeling bearish in June are still in place. Here is the short version: investor sentiment is way too close to euphoric for my taste, the market is struggling to get above key resistance zones, and we have all kinds of bearish divergences on our internal indicators.

In addition to those factors, there are indications that this churning trading range (and even the entire rally this year) has been an exercise in distribution by the smart money. One example is insider selling, which is at an extremely high level.

And, "August through October is not a time that has been historically friendly to the bulls."

The extremes in the asset allocation debate are well known. At one pole are those who believe that successful market timing is impossible over the long run, and that it never makes sense to alter a portfolio on the basis of beliefs about the various asset classes’ relative attractiveness. The only occasions on which those allocations should be shifted are when an investor’s life circumstances have changed; otherwise, it is best to leave these allocations alone.

At the other extreme are those who believe that, not only is successful market timing theoretically possible, it is not all that difficult in practice. As a result, investors should be willing to make large and frequent changes to how much they allocate to each of the asset classes. In fact, some advisers at this extreme believe that it may make sense to shift an entire portfolio from being invested in equities one day to being completely in bonds the next.

EFM- Why is the focus almost always on the extreme. It is valid for only a few advisers. Anyway, they do go on with some valid commentary here and there.

Actively Managed Funds and Bear Markets    (2008)I agree and disagree. It is pretty difficult to predict a recession/bear market with any precisions as to timing. Fine. But take a look at six months ago when the credit damage was obvious. So, you expect things to go up?? They one thing that was going up was inflation. Everything else is just terrible. Why not then turn to cash?
It's not market timing- it's a review of economics.  

In addition to making the argument for passive investing given inefficient stock prices, this paper presents the following clarifications to conventional wisdom: 1) a high percentage of mutual funds underperforming the market index is not evidence that the market is efficient, and may in fact be evidence of an inefficient market; 2) as individuals and institutions opt out of active investing and index, the market may become more competitive, not less; 3) properly measured, about two thirds of all active investors will underperform index funds every year, independent of who chooses to actively invest, or the direction the market takes; 4) the proportion of small-cap oriented investors that must underperform small-cap indices is even higher than two-thirds, despite the fact that the small-cap sector may be less informationally efficient.