The Many Definitions Of Market Timing

by: Ronald Surz


Quantitative easing (QE) has added $4 trillion to bank vaults, more than quadrupling reserves. Given current reserve requirements, banks could lend up to $40 trillion, twice the national debt.

The national debt is $20 trillion and growing. It’s $156,000 per household.

Most investors fear the possible repercussions but no one knows when and how the worst will come, so there’s serious hope that some form of market timing will work.

Quantitative easing began in 2008 in response to a global economic meltdown. It is a bailout that has been criticized by Fred Thompson and many others, but one pundit justifies it as follows: "If you have to pee on the fire to put it out, you can't worry about cleaning up the pee."

There's no denying that bond markets are being manipulated, and no one knows what the final outcome (cleaning up the pee) will be. This has generated great interest in market timing, and the various related asset allocation strategies that are akin to market timing. In the following, I lay out the various alternatives and their applications.

  • Timing is predicting future prices. Modeling systems seek to identify price patterns that can be extended into the future. Timing is a crystal ball endeavor.
  • Tactical Asset Allocation (TAA) identifies current mis-pricings and is usually used in conjunction with strategic asset allocation, also known as investment policy. In other words, TAA moves asset allocations up or down relative to policy. The terms "tactical" and "strategic" are similar in their military context, and are differentiated as follows:
  • Dynamic Asset Allocation (DAA) uses programmed trading to achieve a goal. The best known DAA is "portfolio insurance" which is an algorithm to create a synthetic put option. Portfolio insurance is the cause of the October 1987 stock market crash because all the programmed trades tried to sell at the same time. Stock market puts are replicated by buying as the market goes up and selling as it goes down.
  • Surplus Management is also called asset/liability management. It usually involves immunizing liabilities (known as "Liability-Driven Investing," or LDI), say of a defined benefit pension plan, by buying bonds that match those liabilities. Then Dynamic Asset Allocation is applied to the surplus above those liabilities. The object is to preserve the excess (surplus) above liabilities.
  • Adaptive Asset Allocation (AAA) adapts to changes in the investor's economic situation, and can be used for goals-based investing in what Dr. Frank Sortino calls "financial navigation." Progress toward the achievement of objectives is monitored and risk is adjusted upward if objectives are not being met, or downward if they are met.

Each approach has a purpose. Timing and TAA are the only two with the express purpose of getting out of the way of the next storm. The others are useful for other specific purposes.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.