The Seduction of Market Timing
Here is the dirty secret about market timing: Claims of success are exaggerated — big time!
Every investor wants to buy the bottom, and (especially) to sell the tops. This is so deeply craved that investors want to believe it is possible. In the wonderful world of financial news, this defines the opportunity.
The best sales approach is to claim expertise in market timing. This often means citing a single dramatic moment:
- Predicting one of the various bubbles is an especially great credential. It is especially humorous when the expert is introduced as being an "early" forecaster of housing problems. There were many who qualified on that front who did not have good investment results over the entire cycle.
- Calling the bottom in 2009. There were a series of nominees on this front as well. Someone was calling a bottom nearly every week, and there were a few big winners.
A Brief Digression for a Small Quiz
Anyone who follows financial media is a consumer of market punditry. Here are some regular pundits. How would you rank their market-timing advice? Just put a number next to the name.
Abby Joseph Cohen
The Current Question for Investors
The average investor is too easily swayed by smooth-talking experts on TV. I want to discuss this in two parts — some observations I made in 2010 and then an update on current issues and pundits.
Here is the key point:
Learn to distinguish between market commentary and specific investment advice!
When Warren Buffett (or Jeff Miller) provides a market commentary, it is not intended as investment advice. It is a general market observation. Anyone who starts by saying that "he got me out of the market in 2008" or "he got me invested in 2009" is making a mistake. This is not the right way to think about your future.
Your investment program should be like a made-to-measure suit — just for you.
I went on to suggest the following advice:
For retirement clients I consider five different strategies.
- A bond ladder — near-term instruments roll off and we go out to the end of our time frame, currently eight years. This leaves us less sensitive to increasing rates. this is very important right now.
- Dividend stocks. I emphasize the stock-picking part of this. Buying a poor stock with a good yield is not the answer.
- Covered calls. Writing calls against stock positions adds to income. If you do a good job of picking the stocks and which calls to write, this can be a major boost to yield. I have a method combining fundamental and technical analysis. It is not just a matter of finding the highest premium.
- Stocks. Yes, stocks belong in the portfolio of nearly everyone. You are never too old to own a great growth stock.
- ETFs. A disciplined ETF strategy should be part of nearly every portfolio. There is a need to establish rules and to follow them.
So the key point is that you should not go "all in" or "all out" because of something you read or see on financial TV.
With this in mind, let us return to a review of forecasts. These are the people that you read in the financial press or see on TV. The principal credential offered is that they are often quoted or on TV!
Wouldn't it be nice to know whether famous pundits had a good track record? One of my missions at "A Dash" is to find the best experts. Beware of those who pretend expertise that they really lack.
A great source for track records is CXO Advisory. This source is objective and strong on research methods. The guru grades page shows the public record of many of the people we follow. You can check out the individual analysis to see exact public statements and the interpretation. I strongly recommend frequent visits to this site. But let us check out the quiz list. I made it easy by listing them in order of success.
The first thing we should note is that most pundits bat less than .500. The second impression is that, with the exception of Cohen, the doomsters are at the bottom of the list. This is surprising given that the decade featured includes some of the worst performance in history.
Analyzing John Hussman
CXO does not have a grade for John Hussman because the story is too complicated. Hussman has had reasonable returns — not as good as the best of us, but with lower volatility. The key thing to understand is that he provides no edge in market timing, and that is where he gets his major publicity.
Most recently he writes that this is one of the worst times to invest, and he is featured in Barron's and widely cited. Here is Josh Brown's summary. Regular readers know that I do not accept his methodology or his conclusion, because he creates after-the-fact models and excessively tweaks the various parameters. He then adds a layer of dense prose that prevents anyone from explaining what he has done. None of it is peer-reviewed. It is simple data mining, creating a "syndrome" from known results – impossible to disprove.
But put aside my conclusion, and turn to an independent review. Hussman is easy for CXO to analyze since he has a fund with a public track record in addition to his statements. CXO does a careful analysis. Here is the conclusion:
In summary, while hedging has generally been advantageous for equity investing over the past 11 years, evidence from simple tests provides little support for a belief that John Hussman successfully times the stock market via hedging adjustments based on his assessments of market valuation and market action.
Note that this review was done before the recent market rally, where Hussman again has been wrong. The review explains that whatever risk-adjusted advantage Hussman gains comes from stock-picking, not market timing. For consumers of his regular market commentaries, this is bad news.
I often feel lonely in offering the most important advice for investors:
- Asset allocation is a personal decision, based upon your own circumstances.
- Find a plan that fits your investment time frame and needs.
- Don't think that there is a magic system to time the market.
My own methods reflect potential gains and risk, the classic investment tradeoff. Meanwhile, exaggerated reactions to news occur constantly. Beware.
UPDATE 3/24/12, 10 AM CDT: The original post had a typo giving an incorrect score to Marc Faber. Thanks to reader JM for pointing this out. I apologize for the error.