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.

Pundit
Ken Fisher
David Dremen
Louis Navellier
Laszlo Birinyi
Doug Kass
Marc Faber
Bernie Schaeffer
Jim Cramer
Stephen Leeb
Jim Jubak
Charles Biderman
Bill Cara
John Mauldin
Gary Shilling
Bill Fleckenstein
Abby Joseph Cohen
Peter Eliades
Robert Prechter

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.

Quiz Answers

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.

Conclusion

I often feel lonely in offering the most important advice for investors:

1. Asset allocation is a personal decision, based upon your own circumstances.
2. Find a plan that fits your investment time frame and needs.
3. 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.

Comments

[JWG]

I sure was surprised to see Marc Faber so high on the list. The world does not end every 3 weeks, but if you read him only for tone, you'd certainly think so.

There may be a lessson here. Some pundits always have a bullish or bearish tone, and you have to listen to them closely and read between the lines to notice their contrary calls.

Very interesting article.

JWG

[Samuel]

So, seems doing the reverse of Prechter would produce a return of 77%, beating the best of the best? Need to have a Contrary Prechter Fund!

Interesting stuff, thanks,

Samuel

[Robin Kirk]

That is a very sound advise. It is very important for investors to identify the smartest place to allocate your assets. To be able to do this, you need to have a credible research and good strategy on what to do with your money and assets. Learn to evaluate the market and review the forecast before you jump into conclusions. Better yet, consult a professional and ask what is the best investment plan that is suited for you and your assets.

[Kevin Beamer]

Those are the list of the most influential and rich businessmen across the globe. They sure had those blend of magic marketing and characters a businessman should have. No wonder they have reached the peak of their success.

[oldprof]

Angel -- I hope that you and everyone else got the major message: None of the pundits is good at market timing. I am not trying to highlight small differences. They are all in the coin flip range (with a few exceptions).

Your asset allocation should be much more a function of your own situation rather than your interpretation of macro events.

I realize that this is counter to your own approach, but you are free to take your own risk. I have the job of advising many investors. This is a serious responsibility, especially now.

What is a big payoff? Since I think the Dow is going to 20K in a few years, that is big enough for me.

Good thoughts, as always.

Jeff

[Angel Martin]

Jeff, this is a really good article, and a lot to think about !

I was not surprised to see Ken Fisher at the top, and Prechter at the bottom.

but as you state, it is a hard thing to measure for pundits. I commend CXO for trying to create objective measures for this.

At the same time, looking at the detailed results that CXO has for Fisher, he made three bad calls just before and during the financial crisis which would have cost an index investor 50% of their money. Yet, in 2006 he is credited with twice as many good calls when the S&P was up all of 13%. Clearly, not all calls have equal impact.

Jeff, like you said, it really depends on the the individual investor and the portfolio. If someone is mostly on a bond ladder, a missed recession call might not matter that much, but it would for someone with heavy index exposure.

Also, the results from CXO suggest to me that since the performance for even the best pundits is not very good, if one is going to try to invest based on forecasting major market moves, you need a strategy where the payoff is big enough when you are right to make up for all the times you are going to be wrong.

[Kevin]

Thanks for this post. I agree with the "dense prose" comment and the fact that Hussman is a market timer, even though he denies it.

I am a long time investor in his funds. However, I usually start with a small allocation, and in the early 2000's it did great, but since, not so much.

In particular, his "ensemble" methods ( his word) has come about from something that is completely predictable/simple to explain. He didn't use indicators all the way back to the depression (and beyond). The markets since ~ 2007 haven't been typical post-war markets, his data set got a big fail.

I have now out-performed him over the past 12 years by my basic timing and allocation methods. (Similar to GTAA).

Thanks for your blog.

Kevin

[oldprof]

Richard -- I do not manage a mutual fund upon which we could calculate a risk-adjusted return. I have six different investment programs which cover a broad spectrum of risk and reward. I start by asking whether a client needs to preserve wealth or create wealth. We go from there, finding a good balance for their needs.

My intended theme for the article is not who has the best returns or which pundit to follow. It is the danger of following anyone (including me) as a basis for going "all in" or "all out." Your asset allocation is much more complicated than that.

Returning to NewArc's results, I provide performance data to prospective investors as a part of the process of determining their needs and making a proposal. RIA's and hedge funds cannot legally advertise returns. Newsletter writers can make all sorts of outrageous claims, since they are regulated differently.

To summarize -- I am happy to discuss our specific program returns with any interested investors.

But that is not the point of the article.

Thanks for giving me a chance to explain what we do.

Jeff

[Richard]

Jeff
In keeping with the theme of your article, what is your risk adjusted return for the past ten years?

[Steve]

Jeff

This is a really good - and important - post. Now and then I look back through copies of articles from Barrons or WSJ or whatever I've cut out and the forecasts of so many "advisors" are just plain wrong. And yet they keep appearing on TV and in print.

I used to read Hulbert's column in Forbes and from his analysis I learned to stop paying attention to them and focus on doing my own analysis and investing work.

Steve

[d]

I noticed that you are not on this list.

It has been years since I read a more egotistical financial blog post without having made some sort of a call.

"My point, of course, is not to recommend or reject any specific source as much as it is to show the difficulty involved."

You could have done more to discuss others on that list rather than slam Hussman.

Marc Faber has been listed as a gloom and doomer but he is near the top of the list.

This sort of post is disrespectful to others in this industry.

[oldprof]

Proteus -- You are correct in observing that I provided only a partial list, mostly based upon those that frequently appear on TV or are cited in popular print media. There are several others than I could have included (Bob Brinker, Bob Doll, Bill Gross), and I urge people to refer to the page for their own research.

Thanks for your comment, and I hope that others will join in if I have missed someone who should be highlighted.

My point, of course, is not to recommend or reject any specific source as much as it is to show the difficulty involved. Thanks for citing Hulbert on that point.

Jeff

[Proteus]

The Hulbert Financial Digest's current issue also discusses just how difficult timing is. Only one newsletter made his "Honor Roll" for timing that is above average in both up and down markets.

I think it's only fair to add that CXO lists several gurus that have reasonably good grades that you did not include (I assume that's because they don't regularly appear on TV or print and don't qualify as pundits). For example, I think Carl Swenlin is worth following.