Market Pulse: Market timing
The market was weak in late January, rallied, and turned weak again a month ago. Wouldn’t it be nice to be invested when stocks go up and in cash when they go down?
Of course, but if it were that easy everyone would do it. Here’s my view on market timing:
Anyone who incorporates market timing reduces the risk and volatility of his or her portfolio. A portfolio that is temporarily in cash is always less volatile than a portfolio that remains fully invested. Market timing reduces portfolio draw-downs, possibly keeping risk-averse investors in the game.
For the vast majority of investors, including myself, market timing also lowers long-term returns. As an example, the most popular timing method uses the 200-day moving average, where you are invested when the S&P 500 is above the moving average and you are in cash when it is below the moving average.
Over long periods this timing method has lowered portfolio returns over a buy-and-hold, but it also reduces volatility.
In my book “Exchange Traded Profits,” I introduce a unique timing method that looks at the performance of the Nasdaq Composite relative to the S&P 500. The Nasdaq is like a mood ring for the market. It tracks stocks that tend to be more volatile and aggressive than the blue-chip stocks represented in the S&P 500.
When big money players like the market, they rotate to the Nasdaq stocks because of their better growth potential. When investors are nervous they prefer the safety of the less volatile S&P 500.
My studies show that the most favorable market environments occur when the Nasdaq Composite outperforms the S&P 500. Readers can simply compare the performance of these two measurements to get a sense of the market environment, but I quantified the rule by plugging the relative strength (Nasdaq divided by S&P 500) into a popular formula called the MACD (my book, available at the Washoe County Library, explains this in more detail).
Since 1996, when this indicator favored the Nasdaq the market advanced 234 percent. When the indicator favored the S&P 500 the market only gained 31 percent. This system isn’t full proof, but it is worth watching. The indicator is currently on a Sept. 7 sell signal.
As for the current market, September and October are historically weak months for stocks. Seasonal factors improve in November so that headwind will become a tailwind.
More on that next week.
David Vomund is an Incline Village-based fee-only money manager. Information is found at http://www.VomundInvestments.com or by calling 775-832-8555. Clients hold the positions mentioned in this article. Past performance does not guarantee future results. Consult your financial advisor before purchasing any security.