Jeff sent this post in from the road.
Market timing can help investor returns. The method used should reflect the investor's time frame, trading costs, and risk tolerance.
For investors with a long time horizon, we use market valuation models like the Fed Model to help us with asset allocation. For more agile traders, we use more aggressive market timing.
Whatever the time frame, an interesting place to stop and take stock is the completion of an investment cycle. We like to start with a point where we completely got out of the market. We then consider every trade until the next time we have sold all long positions.
This is a complete cycle.
The August - November Cycle: An Illustration
As we have done for the last several months, we give readers a glimpse of our approach. We have been reporting each Thursday on trades made during the prior week, and also sharing the sector model ratings from the prior day.
The cycle began when we completely exited the market on August 8th. We started buying on August 17th - nibbling really - with a biotech position. As more sectors earned "buy" ratings we added positions, getting to 50% invested by September 4th and fully invested on the next day!
During this time we traded in and out of seventeen different positions. This is important to note. The system is geared to holding eight positions, each representing 12.5% of the portfolio. In many cases where we remained fully invested a stronger position replaced a weaker one. This is a good indication that the sector rotation method was working as we expect.
The other way to exit is when everything is becoming weak. On November 14th we had our first sale with no replacement. By the next day, there were so few positions with a "buy" rating that we were down to 50% invested. On November 20th we sold our last positions.
The complete cycle evaluation helps the manager look at overall effectiveness and also sources of problems. This cycle worked out quite well. Our seventeen trades ranged from a gain of 26% to a loss of 5.3%. The average gain was 4%. Overall, we gained 8.5% on the portfolio in 105 days. This is an annualized rate of 31.7%.
We benchmark against the S&P 500, which actually declined by almost 4% during the same period, an annualized loss of about 15%.
One cycle does not provide as much evidence as extensive testing, but we always like to compare real-time tests with our careful back-testing.