Tempted to become a short-term stock-market timer? Stop! First, read this column about how hard it’s been so far this year for professional market timers to anticipate changes in the market’s shorter-term direction.
That’s because the U.S. stock markets, since January, have provided the ideal setting for short-term timers to beat the market by a large amount. Unlike last year, when the market went more or less straight up and thus created few profitable opportunities for short-term market timing, the market so far in 2018 has experienced several powerful rallies and declines. A good short-term market timer should have been able to exploit that volatility for profit.
For example, from the start of January through Jan. 26, the S&P 500 (.SPX) rose 7.5%, and then proceeded to fall 10.2% through its Feb. 8 low. Over the subsequent two months the U.S. benchmark index did an almost complete replay, rising 8.0% through Mar. 9, and then falling 7.3% through Apr. 2. And then, through Apr. 17, the S&P 500 rose an additional 4.8%.
Putting all these rallies and declines together, the S&P 500 through Apr. 17 was essentially flat — gaining 1.8%. But a short-term timer who perfectly caught these peaks and troughs by being 100% long during the rallies and 100% short during the declines would have been sitting with a 43.7% profit as of Apr. 17. That’s a huge difference; even a short-term timer who only partially anticipated these rallies would be far ahead of a buy-and-hold strategy.
To get a sense of how poorly short-term timers as a group responded to these profit opportunities, consider their average equity exposure at the tops and bottoms of each of these rallies and declines. At the Jan. 26 top, for example, the average among more than five dozen short-term timers I monitor was 68.7%; at the market’s Feb. 8 bottom, in contrast, it was 19.4%.
That’s just the opposite of what they should have done, of course. They should have had relatively low exposure at the market’s top and relatively higher exposure at the market’s bottom. Because they didn’t, they suffered more of the market’s decline than they benefitted from the market’s subsequent recovery.
They bought high and sold low, in other words — a sure fire way of losing money.
The short-term market timers added insult to injury in the subsequent rally and decline by repeating the same pattern. At the market’s Mar. 9 high, for example, their average equity exposure was 50.4%, but at the Apr. 2 bottom it was 10.3%. (See accompanying chart.)
To contrarian analysts, of course, the short-term timers’ behavior this year is hardly surprising. Their actions are exactly what provide the foundation for contrarian investing: Market timers as a group are bullish when they should be bearish, and vice versa.
Surprising or not, however, the market timers’ behavior illustrates the formidable challenges we all have trying to catch the market’s shorter-term gyrations. The market timers I monitor are not amateurs, after all. They are professionals who follow the market on a full-time basis and who charge as much as hundreds of dollars a year for their advice. Furthermore, virtually every market timer I follow knows, at least in theory, that there is a kernel of truth underlying contrarian analysis — that they should be bullish when bearishness is at an extreme, and vice versa.
And, yet, despite their knowledge of the contrarian pattern, and despite devoting their full times to market timing, they still as a group fail dismally.
To be sure, I’m basing my analysis on an average, and some individual timers did better than this. Furthermore, there are other reasons to consider short-term market timing besides trying to make more money than buying and holding.
One other reason, for example, is to reduce volatility and risk. We know that, one of these days (weeks, months), a short-term decline will actually be the beginning of a major bear market. If avoiding that bear market decline is important enough, you will be willing to treat every short-term dip as the occasion for getting out of stocks — knowing in advance that in most cases the market will turn back up shortly after you get out.
But if you are trying to time the market’s short-term gyrations in hopes of making more money than buying and holding, it should give you great pause that professional market timers, as a group, find it incredibly difficult to consistently do that successfully. You need to ask yourself why you think you are so much smarter than they are.
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