Monday, 3 December 2012

The Verdict on Market Timing

Many professional investors move money from cash to equities or to long term bonds on the basis of their forecasts of fundamental economic conditions.  This is one reason many brokers give to support their belief in professional money management.

John Bogle, founder of the Vanguard Group of Investment Companies said, "In 30 years in this business, I do not know anybody who has done it successfully and consistently, not anybody who knows anybody who has done it successfully and consistently.  Indeed, my impression is that trying to do market timing is likely, not only not to add value to your investment program, but to be counterproductive."

Over a fifty-four year period, the market has risen in 36 years, been even in 3 years and declined in only 15 years.  Thus, the odds of being successful when you are in cash rather than stocks are almost 3 to 1 against you.

An academic study by Professors Richard Woodward and Jess Chua of the University of Calgary shows that holding on to your stocks as long-term investments works better than market timing because your gains from being in stocks during bull markets far outweigh the losses in bear markets.  The professors conclude that a market timer would have to make correct decisions 70 percent of the time to outperform a buy-and-hold investor.  Have you met anyone who can bat 0.700 in calling market turns?

An examination of how mutual funds have varied their cash positions in response to their changing views about the relative attractiveness of equities.

Mutual fund managers have been incorrect in their allocation of assets into cash in essentially every recent market cycle.

Caution on the part of mutual-fund managers (as represented by a very high cash allocation) coincides almost perfectly with troughs in the stock market.

  • Peaks in mutual funds' cash positions have coincided with market troughs during 1970, 1974, 1982, and the end of 1987 after the great stock-market crash. 
  • Another peak in cash positions occurred in late 1990, just before the market rallied during 1991, and in 1994, just before the greatest six-year rise in stock prices in market history.
  • Cash positions were also high in late 2002 and in March 2009, at the trough of the market.

Conversely, the allocation to cash of mutual-fund managers was almost invariably at a low during peak periods in the market.

  • For example, the cash position of mutual funds was near an all-time low in March 2000, just before the market began its sharp decline.  
The ability of mutual-fund managers to time the market has been egregiously poor.  

Ref: A Random Walk Down Wall Street by Burton G. Malkiel

Two ways to profit from the market swings: Timing or Pricing

Since common stocks, even of investment grade, are subject to recurrent and wide fluctuations in their prices, the intelligent investor should be interested in the possibilities of profiting from these pendulum swings. There are two possible ways by which  he may try to do this:

  • the way of timing and 
  • the way of  pricing.

By timing we mean the endeavour to anticipate the action of the stock market

  • to buy or hold when the future course is deemed to be upward
  • to sell or refrain from buying when the course is downward. 

By pricing we mean the endeavour
  • to buy stocks when they are quoted below their fair value and 
  • to sell them when they rise above such value. 

less ambitious form of pricing is  the simple effort
  • to make sure that when you buy you do not  pay too much for your stocks. 
  • This may suffice for the defensive investor, whose emphasis is on long-pull holding; but as  such it represents an essential minimum of attention to market levels.

We are convinced that the intelligent investor can derive satisfactory results from pricing of either type. 

We are equally sure that if he places his emphasis on timing, in the sense of forecasting, he will end up as a speculator and with a speculator’s financial results. 

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