Tahoe Market Pulse: Market timing can be very difficult
It’s been well over five years since the S&P 500 dropped 15 percent, and the VIX, a measure of market volatility, is at a 2 ½ year low.
This is a difficult environment for market timers (those who jump in and out of the market). My view is that over the long run market timing reduces portfolio returns, but that is especially true lately.
That said, market timing has its benefits. 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.
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 doesn’t increase portfolio returns over a buy-and-hold, but it does reduce 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 230 percent. When the indicator favored the S&P 500 the market only gained 15 percent. This system isn’t full proof, but it is worth watching. The indicator is currently on a January 13 buy signal.
Market timing is very difficult, but here is a rule that usually applies: sell when you want to tell your friends how well your portfolio is doing, and buy when you would rather talk about anything other than the market!
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.
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