'Market Timing Is Impossible'

That was the response of a certain Nobel Laureate when I tried to get him to read my paper, "A Quant Approach to Tactical Asset Allocation." He refused to even take a look at it.

This year has certainly been the perfect storm for buy and hold investors. Everything has gone down - Stocks, Foreign Stocks, REITs, Commodities, and (some) bonds. This has been an instructive year to showcase the benefits of a market timing solution, namely, risk management and avoiding large losses. I have no idea how big this decline will be or when it will end, but it is instructive to take a look at some historical relative performance of the timing model vs. buy and hold investing.

October 1974 ended a period where buy and hold had its highest drawdown ever at around -20%. That has now been eclipsed by the current -30%+ drawdown. (The maximum timing drawdown is around -10%.)

Below is a chart for the relative returns of buy and hold vs. the timing model. Readers know that both have similar compounded returns over the past 36 years, but that the timing model has much lower volatility and drawdowns. Usually one outperforms the other by a maximum of around 10% before mean reverting.

(Click on the chart to enlarge)

However, in times of severe market stress (now), the timing model can outperform by far greater amounts. As of the end of October, it was outperforming by about 27%. Has there ever been a period comparable?

By October of 1974 the timing model was outperforming as most asset classes were declining severely (with the exception of commodities). The timing model ended the year with a gain of around 13% vs. a loss of -12% for buy and hold. However, buy and hold mean reverted over the next year, and returned about 20% for 1975 while the timing model would have done about 2%.

The million dollar question is, how bad is it gonna get?

(Stay tuned to a follow-up post on some thoughts I have here.)

Comments

[Everyoneisa...:]

Can you elaborate on your timing strategy?

2008 Nov 21 08:25 AM

[Augustus:]

Click on the Author name. His earlier articles are available here and it is fairly well laid out. In addition there is a paper that you can download that will give the data for the different assets.

2008 Nov 21 12:24 PM

[carey_jim:]

You are certainly wrong. Just track my stock picks, sell when I buy and buy when I sell and you will be guaranteed success in the market.

And always remember Churchill's observation about man:

Man will occasionally stumble over the truth but most of the time he will pick himself up and continue on.

2008 Nov 21 12:33 PM

[Did U Think...:]

There is no need to time the markets right now because they are in mania unwind mode for some time to come. Just buy 2010 puts on almost anything and wait for the crash to play out. No timing needed. Buy and hold the puts. This is FAR outperforming any attempts to time the market week by week.

2008 Nov 21 12:50 PM

[dc1:]

PS: There are NO guarantees in the stock market. Period.

2008 Nov 21 03:36 PM