The Efficient Market vs. Market Timing: A Strategy for Every Market Condition

With the rain ceaselessly falling in our little town of Piedmont and the bike tuned and waiting for just a spot of sunshine, it is time to re-evaluate midyear market action.

Does the stock market reflect, in its pricing, all information available at any given time? This question has been batted about for years by the efficient market or “random walk” theorists on one side and the market timing specialists on the other. In this week’s Barron’s, Burton Malkiel, author of "A Random Walk Down Wall Street", stands firm in his belief that the individual investor is best served by buying and holding broad market exchange traded funds (ETF) such as SPY. Whereas Bill Gross in his July publication states that “the efficient market hypothesis was always dead from the get-go.” He foresees stock markets performing below average for an extended period of time allowing astute investors to beat the market's random walk.

Alpha is the pay dirt to which the active manager devotes his/her working days and sleepless nights. Judging by the popularity of and the tremendous energy dedicated to the internet site Seeking Alpha, thousands of bloggers also subscribe to the theory that it is possible to outperform broad markets without additional risk.

I am one of the devotees to the alpha camp, believing that the time invested in searching profitable opportunities does pay off with returns better than just buying and holding the broad market as represented by the S&P 500.

Like Bill Gross, I assume markets will produce below historic returns for the next several years. We will continue to pay the price for past errors of excessively easy money and overly hyperactive consumers. Higher savings rates and corporate taxes will yield lower corporate profits. In addition, some 15 trillion dollars of equity was wiped off American households' balance sheet from the recent economic crisis, making them reluctant to make risk investments anytime soon.

There is an investment strategy for every market condition and in a single digit return market, covered call writing is ideal. Receiving cash for time both lowers risk and improves performance. It is the alpha tool for a directionless market.

Returns of 1-2% monthly can be found by writing in-the-money calls on large cap stocks. I have a few suggestions for August, six weeks away:

Chevron (CVX) at 63.35 with August 60 calls at 4.90

Wal-Mart (WMT) at 47.9 with August 47.5 calls at 1.75

Johnson & Johnson (JNJ) at 56.6 with August 55 calls at 2.50

Barrick Gold Corp. (ABX) at 33 with August 32 calls at 2.7

*Note that S&P 500 was at 893 on July-07-2009 at time of writing of this commentary report

Author’s Disclosure: The author is long the following companies and short the calls: WMT, JNJ, ABX

Comments

[TLassen:]

The Efficient Market Hypothesis says that market prices are fair and that they fully reflect all available information. This does not mean that prices are perfect or that markets are rational; some prices may be too high and some too low, but there is no reliable way to tell. There is no Technical or Fundamental Analysis method or any other investment strategy that can be used by investors (individual or money managers) to expect to earn above-average profits without assuming above-average risks. Market efficiency does not suggest that investors can't "win." Over any period of time, some investors will beat the market, but the number of investors who do so will be no greater than expected by chance.

A little late in posting my comment, sry.

Sep 27 05:41 PM