Market Timing

In the past I, like many general investors, shied away from the concept of market timing. It was viewed as too difficult, and many investors left the markets when stocks went down and then missed the rally on the way up, essentially “buying high and selling low”. Instead, investors were advised to “stay the course” and keep investing, assuming that, over time, the rising markets would reward continuous faith with high returns.

An article in Sunday’s Chicago Tribune showed in a crystal clear fashion that, in fact, market timing is the ONLY issue for stocks, at least nowadays. This article shows stock performance for the top 50 stocks by market capitalization based in the Chicago region.

EVERY SINGLE STOCK is showing positive performance over the last 12 months! What are the odds of that, assuming that the stock market has its ebbs and flows? Very remote. The ONLY issue in the market over the last few years has been timing; everyone lost in late 2008 when the market cratered, and everyone who bought in at the trough made a lot of money. Likely to see this same article in late 2008 virtually 100% of the top 50 firms would be in negative territory over the prior year.

While I can’t say for certain what is driving stock performance UP (now) or DOWN (2008), I can say that virtually the entire market is extremely correlated with this phenomenon, as indicated by the top 50 stocks all being in positive territory.

Recent articles I have seen point to returns as being closely tied to the P/E level; when you buy into a “cheap” P/E market, you do well; when you buy into an “expensive” P/E market, you do poorly. While no one can say for certain what cheap or expensive really means, that broad theory is one that might be crucial to stock investing post 2000. In modern history (the last 30 years) there hasn’t been a long period where stocks traded in such a narrow range (around the Dow 10,000 level); but we need to decide how to weight the last few decades against the entire history of the stock market.

While I am not a professional stock adviser, the fact that 50 out of 50 of the top Chicago stocks (by market capitalization) are all up has to be a signal of some sort.

Cross posted at LITGM and Trust Funds for Kids

5 thoughts on “Market Timing”

  1. To me this has always been intuitively obvious. Essentially, if you had bought these stocks a year ago, you would have bought undervalued stocks since investors were being overly pessimistic.

    Investors are (IMO) currently somewhat overly optimistic. However I think this actually reflects half reality – that the companies (and economy as a whole) haven’t performed as badly as investors feared they would a year ago – and half that current investors are assuming that there is currently a proper recovery underway and that these companies are going to do well.

    I think there is a recovery of sorts underway at the moment, but not to the extent that the media (and by extension the public) think that it is. So if I were a betting man I would bet that they are headed down over the next year or two, or at least that they won’t perform anywhere near as well over the next year as they have over the last year.

    However that’s far from a sure thing. Call it a gut feeling. I will be interested to look back in a year and see how my predictions pan out.

    I think what you are saying about the P/E ratio is, to some extent, true. I certainly agree with Buffet that if you are looking to invest outside of a boom or bust, you have to evaluate companies based upon their future profitability before making investment decisions. P/E ratio is far from the only indicator of future profitability but it is a useful piece of data nonetheless.

    The bottom line is I think you can make money on the stock market in one of two ways – either by betting on the market a whole, or by doing your homework and investing in sound companies (or shorting unsound companies). Both are valid methods with very different approaches and different amounts of risk.

  2. I would suggest that a lot rides on the November election. If the Republicans take the House, and especially if they take both the House and Senate, look for a rally. Look at the stock market charts of the 90s. The great bull market took off after November 1994.

  3. Since I am a very infrequent commenter to this blog I will keep my comments short. Politics is often over-rated when it comes to stock market performance (barring laws that are passed that directly and clearly affect the profitability of an industry.) The November election will be a minor factor.

    Timing the market is a very difficult skill set to acquire and it mostly can not be done casually. In fact selecting individual stocks should be something most individual investors should stay away from; an individual investor will simply not have the necessary edge to win out over professional traders, investors, and market-makers (i.e. stick with well respected, low cost mutual funds & e.t.f.s.) Als0, P/E is an atrocious metrics to rely upon (I assume that it was used in this post simply as an example); earnings can be manipulated in any number of ways that the casual investor will not be able to identify because they will not have gone through the financial statements, analyzed the numbers with some type of financial model, made comparisons with competing firms, talked to vendors, competitors, insiders, etc.

    Lastly, don’t rely upon hindsight as a determining factor in your stock selection process.


  4. Thanks for the comments.

    The issue is that the massive covariance of all the stock moves indicates that in fact some variable is driving ALL the prices up or down. This is a rather new phenomenon, at least in its intensity and uniformity. In this issue, it doesn’t matter what you are picking, if you are in the market when it all heads south you are a loser and if you are in at all it doesn’t matter what you pick you are a winner.

    Agreed that market timing is difficult and in my profession I am very well acquainted with the ways P/E works and can be manipulated. However, the research that I have been seeing recently is showing that P/E has been having some predictive value over the last decade or so.

    Also – I think a lot of the old stock market history is getting less useful because the US is now such a small part of the world wide market, relative to the post-war era. The majority of the IPO’s are overseas and we face (pretty much) the worst corporate tax rates in the industrial world and many other dis-incentives to US investing from Sarbanes to punitive environmental regulations, and the nation is so indebted and slow-growing that this burden is likely to get worse. A lot of time fundamental competitiveness bailed out the US market but that is getting to be a heavier burden nowadays.

    Just my 2 cents.

  5. Trendfollowing.

    Plot a triple moving average of the S&P 500 – I generally use 200, 70, and 15 days. When the short is above the medium, and the medium is above the long, go long. When they are in the other order, go short. In any other circumstance, get out. You won’t be in at the bottom, or out at the top, but you’ll generally hit most of it.

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