With the market hitting new highs last week there are two camps of investors in the marketplace. Those that have participated in the current bull market and are wondering how high it goes, and those who are on the sidelines hoping for a stock market correction so they can get in. It’s been a pleasant ride for those who are in the market and frustrating for those who are not.
Both groups struggle with their respective stock market dilemmas and wish there was a market timing system that could reliably predict tops and bottoms. Market timing is a controversial subject in investment circles with some claiming it’s possible but most claiming it’s difficult if not impossible.
Gradient Investments believes market timing is difficult and endorses a more consistent approach that allocates your investment portfolio according to your individual investment objectives, risk profile, and time horizon. In addition we endorse rebalancing and making allocation changes to investment portfolios as we wind through various points in the market cycle.
There will always be investors who look for the silver bullet that can consistently time the market. And there is always a surplus of money managers who claim they have a successful strategy that engages market timing. Should investors jump into these strategies claiming to pick tops and bottoms? Should investors blindly invest with someone who didn’t lose them money in 2008?
Let’s look at a study Mark Hulbert of Barron’s did in 2013. He analyzed the returns from October 2007 to March of 2013 of more than 100 market-timing newsletters and web-based advisors monitored by the Hulbert Financial Digest. Most of these timers also are money managers who will deploy their timing strategies for a fee. He focused only on that portion of returns directly attributable to their market-timing calls and found:
- Not one market timer called the top in October 2007 and the bottom in March 2009
- Of the 140 timing strategies, just 15 of them had significantly lower equity exposure on Nov. 9, 2007, than they did on the day of the top a month earlier
- And of those 15, just six had a markedly higher equity exposure on April 9, 2009, than they did a month earlier, on the day of the bottom
The point is that market timers need to make three correct decisions. When to get in, when to get out, and when to get back in again. The chances of getting all of these consistently right are slim. Yes a manager may have saved you money in 2008, but how much have they made the 6 years since the market bottomed? Chances are their returns are significantly below what the market has returned. It’s very difficult to market time a prolonged bull market. The chart below highlights how missing some of the best days in the market (versus staying fully invested) can devastate your portfolio:
As we’ve seen, when markets turn, they turn quickly in both directions. Trying to time your entry and exit may cause you to miss the bounce and lose a lot of performance.
Charles Schwab also performed a study looking at how annual timing strategies performed. Following are the 5 strategies studied:
- The “perfect timing strategy” assumes you invest $2,000 at the market low each year for twenty years
- The “invest immediately strategy” puts the money in at the beginning of each year
- The “dollar cost averaging strategy” puts in equal amounts each month
- The “bad timing strategy” invested at the high point of each year
- Finally, the fifth strategy stayed in 30-day T-Bills always
The chart below shows that even if a “perfect timing strategy” did exist, it barely beats “investing immediately” and “dollar cost averaging” strategies over time. And finally even bad timing trumps staying in cash and not investing at all.
What I’m attempting to highlight in this article is that market timing or tactical investment strategies have had dubious historical results. There’s a reason you hear from so many market timing money managers. Their systems/algorithms/factor models etc work until they don’t. When they inevitably fail the market timer just moves on and the client is left holding the bag. Think about it, if you had a system that consistently picked tops and bottoms of asset classes you wouldn’t need to work at all. You’d simply buy and sell perfectly for yourself from your own tropical island. And the last thing you’d do is share your system with the investing public.
Below are 4 questions to ask when considering a market timing strategy:
- Do they have an actual return history (not back-tested hypothetical results)?
- How did the strategy perform in 2008 vs. the market?
- How did the strategy perform in 2009-2014 vs. the market?
- Do they have their own capital invested in the strategy, or are they only charging you a fee?
We think a longer term outlook with a portfolio allocation that fits your particular financial needs is a superior investment strategy. Remember this time tested adage: It’s time in the market, not timing the market.
As of August 22nd, 2014:
Dow Jones US Moderately Conservative Index is up 5.44% (TR) for the year
S&P 500 closed at 1,988.40 up 9.02% for the year
U.S. 10 year Treasury Futures are yielding 2.40% down 0.57% for the year
WTI Crude Oil futures closed at $93.71 down $4.99 for the year
Gold closed at $1,278 per ounce up $74 for the year
To expand on these market reflections or discuss other portfolio strategies please don’t hesitate to reach out to the Gradient Investment team.
