If you wanted to pick a time to get out of the stock market, now looks like a good opportunity: The Dow Jones industrial average has been hitting successive record highs. Selling high today and buying low at some distant point in the future guarantees you a better overall return.
Well, not so fast. While market timing is an awfully tempting investing strategy, picking those highs and lows is far more difficult than you might imagine. Some would say that it’s downright impossible.
The temptation springs from various what-if scenarios. As in, what if you had ditched the S&P 500 prior to the financial crisis and bought stocks back at the market’s trough four years ago? (The answer: You would be up nearly 130 per cent, versus a zero return for buy-and-hold investors, if you ignored dividends.)
The problem is, peaks and troughs are only apparent in the rear-view mirror. Mark Hulbert, who tracks investment advisory newsletters and writes a regular column for Barron’s (among other publications), sifted through his vast database to see how market timers have done since the last market peak in 2007.
Short story: They did terribly.
Longer story: He looked specifically at more than 100 market-timing newsletters and web-based advisers, written by those who feel they have a surefire method for getting investors out of stocks at peaks and back in at troughs.
It isn’t too surprising that no one called the top and bottom exactly right – as in, to the day.
However, when Mr. Hulbert relaxed his criteria – allowing market-timers to call a top or bottom within a month of the actual dates, and shift their equity exposure by just 25 percentage points – 96 per cent of them still failed.
“But even the six that cleared these two hurdles left much to be desired. Each of them issued a number of additional buy and sell signals during the bull and bear markets, above and beyond their well-timed signals that give them bragging rights for ‘calling’ the October 2007 top and March 2009 bottom,” he said in his column.
“These additional signals had the unfortunate effect of frittering away the gains they otherwise would have realized if they had left well enough alone.”
You can see versions of market timing ideas in notes from some professional market strategists as well. Many of them use historical data for previous bull markets as a road map for how long the current bull market will last – and the invariable conclusion is that this is not the market top.
Bloomberg News reported on Wednesday that LPL Financial Corp.’s chief market strategist, Jeffrey Kleintop, believes history is pointing to at least another year of gains.
Mr. Kleintop said that this is the seventh market rally in the post-war period to last at least four years; four of them ran five years or more – and that fifth year produced a spectacular average gain of 22 per cent.
While that might look like a strategy for avoiding market timing, it isn’t: it implies that stocks should be bought at their current levels in anticipation of a big year of gains ahead.
Academic studies support the view that professional fund managers have little market timing skill. A recent paper by Danielle Marie Sougné and Laurent Bodson at HEC Management School and Laurent Cavenaile at the Univeristy of Liege found that just 6 per cent of mutual funds displayed market timing abilities.
It isn’t simply a case that the pros are too bullish. Consider the bearish position of John Hussman: He looked brilliant for avoiding the worst of the financial crisis, but has missed out on most of the rebound since then. And his determination to stay out of stocks, laid out in his weekly notes to clients, looks increasingly frustrated.
So how do you avoid market timing? The surest way is to stick to an asset allocation and rebalance frequently – say, once a year or every month. That way, you lighten up on stocks after they have risen in price, and buy them after they have fallen.
Rather than making a couple of big, futile bets on the direction of the market, you’re making a number of little ones that are completely independent of where you see stocks heading. You won’t sound as clever as the pros, but you’ll beat their returns.