The Market Timing Myth

10/15/2010 Share 0 comments

Brett Arends published this article on WSJ.com:

"For years, the investment industry has tried to scare clients into staying fully invested in the stock market at all times, no matter how high stocks go or what's going on in the economy. "You can't time the market," they warn. "Studies show that market timing doesn't work."

They'll cite studies showing that over the long-term investors made most of their money from just a handful of big one-day gains. In other words, if you miss those days, you'll earn bupkis. And as no one can predict when those few, big jumps are going to occur, it's best to stay fully invested at all times. So just give them your money… lie back, and think of the efficient market hypothesis. You'll hear this in broker's offices everywhere. And it sounds very compelling.

There's just one problem. It's hooey.

They're leaving out more than half the story.

And what they're not telling you makes a real difference to whether you should invest, when and how.

The best long-term study relating to this topic was conducted a few years ago by Javier Estrada, a finance professor at the IESE Business School at the University of Navarra in Spain. To find out how important those few "big days" are, he looked at nearly a century's worth of day-to-day moves on Wall Street and 14 other stock markets around the world, from England to Japan to Australia.

Yes, he found that if you missed the 10 best days you missed out on a lot of the gains. But he also found that if you managed to be out of the market on the 10 worst days, your profits went through the roof."

Brett continued to point out: 

"Consider the data from Professor Robert Shiller at Yale University. He tracks something known as the "Cyclically-Adjusted Price-to-Earnings Ratio." (These days it is also known as "the Shiller PE"). This compares stock prices with after-tax company earnings, but only after adjusting those earnings to take account of the fluctuations of the economic cycle. This helps avoid the distortions commonly found when you compare stock prices to a single year's earnings.

At the peak of a boom, earnings are artificially inflated, while at the trough they are artificially depressed. The Shiller PE smooths that out..."

MyPlanIQ maintains Shiller PE and a model portfolio that is based on Shiller PE to invest. on Advanced Users page, you can find Shiller PE based Shiller Cyclically Adjusted PE 10 Stock Market Timing Strategy and its indicator. 

We do not advocate investors to invest solely based on Shiller PE. However, this PE, along with others, can be of guidance to detect the madness of stock market bubble. 

Read the original article.

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