The mantra of market timing traders is, "Buy low, sell high." Essentially, market timing is asset allocation, i.e., switching your investment funds in and out of equities and interest bearing securities (corporate or government debt instruments) to avoid market declines and capture market tops. When the market has peaked, you sell your stocks and buy bonds. When the market has bottomed out, you sell the bonds and reinvest in stocks. One market researcher studied the stock market from 1946 through 1991. He calculated that the annual overall market return for this 45 year period was 11.2 percent. His research showed that if an investor had been able to timely move his funds out of the stock market and avoid the period's 50 worst months and then get back in (again on a timely basis), the annual return on his funds would have been 19 percent, an increase which would certainly have warranted the effort.
If it were only that easy. How does a trader decide that the bad times are coming? More importantly, how does he or she decide it's time to jump back into stocks?
Technical analysts look at volumes and prices of stocks they follow. Market timers look at the same statistics, but on a market wide basis. If the volume of the overall market is heavy and price advances rapid across the board, the timer looks to pick the top at which he or she sells all equity positions ahead of the anticipated decline. Conversely, when volumes are thin and prices appear totally depressed, the timer sells his or her bonds and moves back into the market, buying equities in anticipation of the upward swing of prices. The market timer might trade index funds representing the S&P 500 or the Russell 5000 Indexes. There are as many indexes as there are market groups. There are bond funds of various types to use when it appears to be time to leave equities. I am sure that timers have other strategies as well. Indeed, there are market timing mutual funds, run by money managers who specialize in this form of trading.
Both investors and traders keep their eye on the relationship between prevailing interest rates for debt instruments and the anticipated returns of equities. If bonds offer a return higher than that of equities by a substantial amount, an individual may conclude that now is the time to load up on debt securities. Professor Burton G.Malkiel described this tension between debt and equities as follows:
The stock market, no matter how much it may think so, does not exist as a world unto itself. Investors should consider how much profit they can obtain elsewhere. Interest rates, if they are high enough, offer a stable, profitable alternative to the stock market. Consider periods such as the early 1980s when yields on prime quality corporate bonds soared to close to 15 percent. Long-term bonds of somewhat lower quality were being offered at even higher interest rates. The expected returns from stock prices had trouble matching these bond rates; money flowed into bonds while stock prices fell sharply. Finally, stock prices reached such a low level that a sufficient number of investors were attracted to stem the decline. Again, in 1987, interest rates rose substantially, preceding the great stock market crash of October 19. To put it another way, to attract investors from high-yielding bonds, stocks must offer bargain-basement prices.
A rational investor should be willing to pay a higher price for a share, other things being equal, the lower are interest rates.*
The market timer has two negatives to overcome with this strategy. Brokerage commissions and fees can put a drag on returns if there is a good deal of trading, and this activity generates income taxes, both of which need to be accounted for when calculating the true return on the investments.There are also some non-technical (and amusing) timing strategies. We will look at some of them in the next blog.
* The material from A Random Walk Down Wall Street
by Burton G. Malkiel, copyright 1999, 1996, 1990, 1985, 1981, 1975, 1973 by W.W. Norton & Company, Inc is used with permission of W.W. Norton & Company, Inc.Comments are always welcome.
No comments:
Post a Comment