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Wall Street warms to ‘market timing’

The ongoing regulatory probe into illegal trading by mutual funds has cast market timing in a bad light, but for many on Wall Street the trading strategy is viable, lucrative and perfectly legal.
/ Source: msnbc.com

The ongoing probe into illegal trading by mutual funds has cast so-called ‘market timing’ in a bad light, but for many Wall Street professionals, the strategy is viable, lucrative and perfectly legal. And some say it could be the best way to make money in the market in coming years.

For years, the investment mantra of Wall Street has been “buy and hold” — a strategy where stocks are bought and held for a long periods of time, regardless of fluctuations in the stock market. Pick a diversified portfolio of stocks, bonds or cash and stick with it, investors were told, because attempting to “time” the stock market (i.e. selling high and buying low) is ultimately futile.

But then came three years of heavy losses in the stock market. Now investors are looking at alternative strategies for making money, and one is market timing. Its adherents say stock valuations because extreme in the late 1990s, and so a period of low returns from stocks is to be expected. Investors should maximize their returns by aiming to anticipate future market moves, the say, and at the same time minimize their downside risks.

“People are really warming up to [market timing],” remarked Chip Hanlon, chief domestic strategist at Euro Pacific Capital, adding that most investors believe in a buy and hold strategy only because it reaped great rewards as stock prices shot higher in the late 1990s.

“Not many people have shaken off this belief yet, but just as a buy and hold strategy was in favor with investors a few years ago, it will fall out of favor when market timing is the only way to make meaningful headway in the stock market,” Hanlon said.

Timing gains advocates
Market timers move in and out of stocks and mutual funds frequently, holding their positions for days, weeks and sometimes months. Their aim is to profit from the ups and downs of the stock market by predicting the best moments to buy and sell. Opponents of the strategy say it practically requires a crystal ball and, basically, is an exercise in futility.

But a number of stock market strategists — including respected money manager and consultant Peter Bernstein — are now advocating the investing tactic. It gained notoriety last month after New York State attorney General Eliot Spitzer announced a far-reaching investigation into alleged illegal trading at mutual funds.

Spitzer said institutional investors and hedge funds have made a fast buck from quickly moving in and out of fund shares, hurting the profits of long-term investors. These traders often evaded mutual-fund company safeguards, but in some cases fund company personnel allegedly helped them to make their trades to the disadvantage of buy-and-hold, long-term investors.

The sort of market timing Bernstein and others advocate differs somewhat from the type named in the Spitzer complaint, where certain mutual funds reportedly conspired to allow certain hedge funds to engage in market timing, while banning it for everyone else. Most mutual fund companies routinely discourage the strategy because it raises transaction costs for the fund.

The broader definition of market timing is perfectly legal according to Dewayne L. Wiggins, a money manager at Lindbergh Capital Management in St. Louis. Wiggins argues it is a legitimate and profitable investment strategy that has been given “a bad rap” by the Spitzer investigation. And contrary to popular wisdom, which says timing the market is impossible, he argues that it is a very simple system can actually prove profitable.

52-week average strategy
Wiggins’ strategy involves buying an index fund that tracks the Standard & Poor’s 500-stock index, a broad measure of the overall stock market, when it closes above its 52-week moving average and selling it when it drops below the same average.

The strategy aims to take investors out of the stock market when the S&P index moves lower and brings them back in when it moves up again, minimizing risk and producing above-average returns.

A 52-week moving average is calculated by graphing 52 weeks of weekly average closing prices. The chart is said to be moving because it is updated every week by dropping the oldest number and adding the newest one and produces a smother curve than simply recording the market’s daily ups and downs.

Wiggins says the approach is the best way to make money when the stock market effectively moves sideways for an extended period of time. Just such a period occurred from the mid-1960s until the early eighties. During that time the tactic would have earned double the returns of an S&P 500 index fund, before dividends, and it would also have taken you out of the market shortly before the start of the recent bear market and returned you to it in May this year.

“No one can time the market exactly, but if you take a very simple system like this one you would have made well above the market’s average return [in a prolonged sideways market],” said Wiggins. If your investment horizon is 30 to 40 years, you’re best off with a buy-and-hold tactic, but most investors’ have an investment horizon of up to 15 years and so should consider a simple strategy to time the market, he said.

But market timing opponents warn that individual investors tend to make lousy market timers.

According to a survey by Boston financial services consultancy Dalbar, mutual fund investors have tended to lag the market’s movements, chasing the market’s spikes and troughs, but never actually timing them correctly. Those spikes and troughs have recently become more frequent and more extreme said Heather Hopkins, a Dalbar spokesperson, adding that the holding period for mutual funds is declining and is now down to 2.5 years.

“Investors continue to do a poor job of timing the market,” said Hopkins. “If you can time the market properly you can do extremely well, but most individual investors don’t have the market savvy or the information to do it effectively. They usually have a full-time job and a family and so they don’t have much time to think about their investments.”