Time pickers, also known as market
timers, mistakenly think they can predict the future direction
of the market. In their effort to time the market, they attempt
to be invested in stocks when the market's going up, and shelter
investments in safe cash, treasury bills or bonds when the
market's going down.
Nobel
Laureate Robert Merton wanted to estimate what a clairvoyant
time picker would earn, so he calculated the value of being
invested in the market at the right time and escaping the
market declines by hiding in Treasury Bills. If an investor
were to stay invested in T-Bills from 1927 through 1978, $1,000
would have grown to $3,600. In the broad market of the New
York Stock Exchange Index, $1,000 would have been worth $67,500.
However, a time picker with the vision to forecast all the
months that the NYSE outperformed T-Bills during the 52-year
period would naturally invest in the market at the beginning
of each of these months. According to this timing system,
$1,000 would have grown to $5.36 billion. Now that
is a real incentive to figure out how to pick the right times
to invest. It also tells you that if timers really had these
psychic powers to see next month's market trends, they would
be all over the cover of Forbes, Fortune, BusinessWeek and
the Wall Street Journal. But they are not.
Is
it possible that there might be a few visionary timers out
there? Sorry, but they just don't exist. In 1978, the wealthiest
individual on record didn't come close to these numbers. Wealth
is not created by purposeful market timing. There may be cases
where one got lucky for a while, but that is not a reliable
strategy for long term investors.
There are numerous time picking purveyors who offer their
visions of tomorrow through telemarketing, fax broadcasting,
newsletters, e-mails, and websites. However, investors should
be aware that these market timing newsletters are not regulated
by the SEC, whose job it is to protect investors. Ironically,
we estimate that millions of dollars are lost every month
by investors who flock like sheep to follow the so-called
expert timers' guesses as to the next direction of the market.
The
landmark and definitive study of time pickers was conducted
by John Graham at the University of Utah and Campbell Harvey
at Duke University. The professors painstakingly tracked and
analyzed over 15,000 predictions by 237 market timing
investment newsletters from June, 1980 through December, 1992.
By the end of the 12.5 year period, 94.5% of the newsletters
had gone out of business, with an average length of operations
of about four years!
The conclusion of this 51 page (see page 25) analysis could not have been stated
more clearly. "There is no evidence that newsletters can
time the market. Consistent with mutual fund studies,
"winners" rarely win again and "losers" often lose again."
This clearly indicates that the market's signals are inaudible
to the thousands of time pickers claiming to clearly hear
them. Any investment professional who speculates on the market's
future should be relegated to the fortune telling parlor.
Jeffrey Lauderman wrote a BusinessWeek article dispelling the
myth of market timing, which he called a perilous ploy and
a guessing game. His 1998 analysis included an interview with
Mark Hulbert, who monitors the time pickers recommendations.
Hulbert's conclusion provided a knockout blow to all 25 newsletters
he tracked. None of the newsletter timers beat the market.
For the 10 year period ending 1988 to 1997, the time pickers'
average return was 11.06% annually, while the S&P 500
stock index earned 18.06% annually and the Wilshire 5000 earned
17.57% annually. The figure below tells the story.
Figure 4-1
Time
pickers vacillate from near zero risk to high risk
and then back to zero risk again. A more rational
approach for investors is to match their risk exposure
to their Risk CapacityT, an approach that is further
explained in Steps 10 and 11. Once that match is established,
the right time to be in the market is when an investor
has money, and the right time to get out of
the market is when an investor needs the money.
"If
I have noticed anything over these 60 years
on Wall Street, it is that people do not succeed
in forecasting what's going to happen to the
stock market."
Benjamin Graham, Legendary investor and co-author of
the 1934 classic, Security Analysis
"Market Timing is a wicked idea.
Don't try it --- ever."
Charles D. Ellis, author of Winning the Loser's Game
"Hulbert's conclusion: None of the newsletter
timers beat the market [over a ten
year period]. The average return was
11.06%. During the same period, the
Standard & Poor's 500-stock index
earned 18.06% annually..."
"There are two kinds of investors, be they large
or small: those who don't know where
the market is headed, and those who
don't know that they don't know. Then
again, there is a third type of investor
- the investment professional, who
indeed knows that he or she doesn't
know, but whose livelihood depends
upon appearing to know."
William Bernstein, The Intelligent Asset Allocator
The underlying assumption of all
forms of stock market picking is that the
picker knows news or information that is not
known to the millions of other market participants.
For continued success, the picker must have
a never-ending source of information not available
to all other traders. Let it go! No mortal
can single-handedly possess such incredibly
powerful and immensely valuable information.
Two concepts that support
the concept that timers are unable to pick
the right times to invest are the Random
Walk Theory and the Efficient Market Hypothesis.
The Random Walk Theory essentially
states that there are no discernible patterns
in stock market prices. The logic and reasoning
goes like this. News moves the markets. News
is both unpredictable and random by definition.
At the moment of discovery, the new knowledge
or information is no longer new and quickly
becomes old news. Since free financial markets
are free of constraints, this new information
is continuously reflected in the prices of
relevant financial instruments. Therefore,
the world's markets move in a random and unpredictable
manner. As an example of randomness, look
at these Wall Street Journal market summaries:
July 24, 2002: The Dow Jones Industrial Average
soared 488.95 points, or 6.4%, to 8191.29
Wednesday -- their second-highest
point gain ever -- as bargain-hunting
and short-covering provided a powerful antidote
for the persistent sell off. The Nasdaq composite
surged 60.96, or 5%, to 1290.01.
The efficiency of communication
has progressed as follows: horseback, slow
boat, smoke signals, homing pigeons, flashing
lights on navy ships, Morse code, telegraphs,
telephones, radios, televisions, computer
networks, and finally the Internet. With each
step, information and news became cheaper,
more accurate, and more rapidly disseminated.
The Efficient Market Hypothesis
simply states that market prices accurately
reflect all available information at all times.
This leads to the conclusion that it is impossible
to consistently beat the market averages.
As Bachelier stated in 1900, the expected
return of speculation is zero. The most recent
studies by Richard Roll indicate that new
information is reflected in market prices
within five to sixty minutes. Within that
sixty minutes there are hundreds or thousands
of traders all competing to profit from the
information. If you are in charge of one billion
dollars, a 0.1% annual gain is worth one million
dollars per year. Consequently, managers of
those funds are applying considerable resources
to squeeze out every little gain from new
information. For this simple reason alone,
there is an absence of opportunities for one
trader to consistently profit from all other
traders who have access to the same information
at the same time! In short, all
of us know more than any one of us and
it is impossible for one person to consistently
possess more knowledge than all the other
traders combined.
To save you some time, all
you need to understand about time picking
is the Random Walk Theory, which states that
nobody can consistently see what tomorrow
will bring. Just remember that news moves
the market and is random and unpredictable
by definition. Therefore, the markets move
in a random and unpredictable fashion. Period,
end of story.
This simple and easy to understand concept
about the markets was first published over
one hundred years ago. Virtually all subsequent
academic studies detailing actual stock market
data conclude that time picking is not likely
to be a successful investment strategy. Unless,
of course, the Goddess Fortuna is directing
your trades with whispers from above.
From 1901 to 1990, the stock market return
was approximately 9.5% per year. The SEI Corporation
completed a study in 1992 that determined
that in order to just equal this average annual
return over the ninety-year period, a time
picker needed to correctly select about seventy
percent of the ups and downs of the market.
Academic Studies Prove that Time Picking Doesn't
Work
The literature is full of studies
confirming the failure of market timing. All
these peer- reviewed research papers share
the same conclusion. Forget about trying to
time the market.
In the paper entitled, "Selectivity
and Market Timing Performance of Fidelity
Sector Mutual Funds," Dellva, Demaskey and
Smith concluded that there was negative timing
ability among the Fidelity sector funds during
the period from 1989 to 1998.
In 1994, Graham and Harvey,
both distinguished professors at Duke University,
studied 237 investment newsletters over the
1980-1992 period. As was stated in the introduction,
they concluded that "there is no evidence
that newsletters can time the market.
Consistent with mutual fund studies, winners
rarely win again and losers often lose again."
Even though financial academics
widely accept the concept of market efficiency,
Wall Street firms continue to pander their
market timing predictions through their appointed
gurus. Their strategy is to encourage their
clients to trade more, even though academics
conclude that trading is hazardous to the
client's wealth. Their annual predictions
of the Dow closing value have been far from
accurate
