How to Become a Market Timing Expert
by Alexander Green, Investment Director
Wednesday, April 29, 2009: Issue #987
With the recent movements in the markets making many question whether we're moving up or down, market timing comes into question. A few weeks ago, our Chairman and Investment Director Alexander Green penned an article on market timing for Oxford Club subscribers...
At the Investment U Conference in St. Petersburg, FL a few weeks ago, my good friend and colleague Mark Skousen called me out.
He told the audience that I was opposed to market timing, but laughed and insisted I was one of the best market timers he knew.
"He railed against the housing bubble four years ago - and he was right!" Skousen declared. "He called oil at $140 a barrel a joke - and he was right again! He has been insisting for weeks that the market was oversold and now it puts on the biggest two-week rally since 1938! Yet he stands up here and tells us no one can time the market. I don't understand it."
Perhaps a few Oxford Club members are wondering about this seeming contradiction, too. Let me see if I can clarify things a bit.
Why Market Timing Doesn't Work
First off - and for the record - no one can accurately and consistently time or forecast the stock market, the bond market, commodities, interest rates, or currencies. You can waste years of your life searching for some market timing system, guru, broker, or money manager who can do this for you.
Let me save you a lot of trouble. It can't be done.
Jason Zweig summed it up nicely in The Wall Street Journal a few months ago, "Uncertainty is all investors ever have gotten, or ever will get, from the moment barley and sesame began trading in ancient Mesopotamia to the last trade that will ever take place on Planet Earth. If tomorrow were ever knowable with absolute certainty, who would take the other side of the trade today? The only true certainty is surprise."
Under ordinary circumstances, most stocks, bonds, currencies, precious metals and real estate are neither a table-pounding buy nor an urgent sell. The markets are not completely efficient but they are relatively efficient. Assets can trade for years - and sometimes decades - without being hugely undervalued or overvalued.
But from time to time things get completely out of whack. Then you can throw your market neutrality aside and jump in - or out - with both feet. How do you know when that is?
Two Market Timing Signals
Watch these two market timing signals and it's simple: When both valuations and sentiment go to extremes.
- In late 1999 and early 2000, the valuations on Internet stocks entered La-La Land.
- Most of these companies had no earnings - many didn't even have sales - and yet investors continued to bid them higher with talk of "The Technology Revolution," "A New Era" and other nonsense.
- Valuations were completely ridiculous.
- Optimism was off the charts.
In January 2000, we called Internet stocks "the greatest bubble of our lifetimes and perhaps of all time." We further warned that investors in the hot net stocks risked getting "wiped out."
Sadly, many did.
When residential real estate became red hot a few years ago, I noted that home prices were rising far beyond inflation, population growth, building costs, discretionary income, or potential rental income. Yet thousands plowed ahead anyway, reminding us skeptics that "they're not making any more land" and "real estate always goes up."
When I noted that residential real estate in Japan had fallen every year for the past 15 years, an Investment U reader fired off a note saying, "Hey, Alex, take a look around. This ain't Japan!"
I hope he's right.
When I wrote a series of Investment U columns last summer calling oil "the mother of all bubbles," I noted that high energy prices always sow the seeds of their own destruction. I cited International Energy Agency data showing that production was rising and demand was falling. Yet speculators continued to bid oil sharply higher anyway. Sentiment was wildly bullish. There was talk among analysts of $500 oil.
Six months later the price of oil was $100 a barrel lower. And so it goes...
The lesson here? During periods of extreme sentiment and outlandish valuations - whether high or low - set aside your market-neutral philosophy and take a contrarian stand. That's why we reiterated our bullish stance on global equity markets in recent months.
But let's not get carried away. We didn't foresee last year's severe credit crunch, or the magnitude of the recent stock market decline. We didn't know the market would begin a historic rally a month ago. And we don't know how long it will last.
No one else knows either. And that's fine.
Embracing The Inherent Uncertainty In The Markets
Accept the uncertainty that's inherent in financial markets. Embrace it. Work with it.
You can't be sure which assets will perform best, so divide your portfolio among stocks, bonds, REITs, gold shares and inflation-adjusted Treasuries. (See our Asset Allocation Model and our Gone Fishin' Portfolio.)
But if you want to become a true market-timing "expert," pay close attention, the secret is simple:
- You can't be sure how high or low your stocks will go - or when they will peak. So run trailing stops behind them to make sure you cut your losses and let your profits run.
- Use this essential discipline - and stick to it - and over time your success is virtually assured.
- You don't have to forecast the economy. Or time the market. Or predict interest rates or currencies. Just take care to avoid the fads, manias and bubbles that arise from time to time.
How do you do that? When you see those two glaring factors - wild extremes in both valuations and sentiment - feel free to "time the market."
Today's Investment U Crib Sheet
Over the past few weeks, Alex Green has been giving readers the kind of market recommendations that they've come to look for from him: cool, steady, levelheaded advice on how to build wealth and protect your assets.
Yesterday, he reminded us why we cannot stray from our asset allocation portfolio and how to accomplish a well-rounded portfolio with Investing Globally: The Risks and Benefits of Foreign Stock Diversification.
And last week, he talked about one of the investments he loves to hate: penny stocks. These speculative investments are the biggest cause of more new investors "losing it all," that we know of. However, Alex showed us a few tricks and hints on what you can do to lower your risk if you must dabble in these dangerous waters.