Can the Pros Time the Market?

November 28, 2011

I never meant to make you cry
And though I know I shouldn’t call
It just reminds us of the cost
Of everything we’ve lost
Bad timing, that’s all
Bad Timing, Blue Rodeo

One of the promises made by active managers is that they can move to cash before the markets tank and then get reinvested before they recover. When markets are as volatile as they have been in recent years, a manager with this skill would be something of a hero.

I recently looked at the record of actively managed mutual funds during bear markets for an article just published in Canadian MoneySaver. I found that there were indeed periods where managers were able to protect investors from losses. The problem was that defensive mangers were usually late to the recovery party. As a result, over an entire market cycle most investors are usually better off staying fully invested all the time.

Shortly after the article appeared, I heard from a member of the investing club I belong to. He told me that one the other club members, Dave Dennis of Newmarket, Ont., had done his own informal study on this subject a couple of years ago. I contacted Dave and he generously agreed to share his findings.

“I went back in the history of both Market Call and Market Call Tonight on BNN during 2008 and 2009 and recorded every time one of the professional guests called for cash as one of their Top Picks at the end of the show,” Dave explained. He plotted those dates with a red dot on a chart a graph of the S&P/TSX Composite Index.

If the market gurus had an ability to identify the best and worst times to be in the market, most of the red dots should appear near the market peaks, and the fewest dots should appear near the troughs. Let’s see how things turned out:

 “In 2008 there were no Top Pick recommendations for cash until July 11,” Dave pointed out. “All the while the TSX index was flirting with 15,000. There were two in each of July, August, and September. Then between October 22 to November 24, a little over a month, there were six cash Top Picks. This last flurry of picks were all made when the TSX had already dropped 30% and was below 10,000.  Some guests even picked cash when the index was approaching 8,000 after a drop of nearly 50%.”

No one claims to be able to move in and out of the markets perfectly, of course. But you will often hear managers say they can add value if they right about 70% to 80% of the time. This chart suggests that most of them come nowhere close to that. Professional money managers, it seems, are subject to the same emotions as retail investors.

By the way, I set out to find the guy responsible for the solitary little dot on July 11. I found him living on a 200-foot yacht in the South Pacific. And the folks who brought you the mess of dots between October 2008 and February 2009? You can see them again tonight on BNN.

{ 25 comments… read them below or add one }

Chad Tennant November 28, 2011 at 9:39 am

Are today’s ‘pros’ or portfolio managers’ glorified speculators with CFA designations? I’ll reserve my answer for another time, but research data would suggest so. People often forget that with anything there are degrees of excellence along a natural distribution curve. Whether it be a doctor, teacher, financial advisor or portfolio manager, everyone by definition cannot be excellent which is why due diligence is important.

Many decades ago portfolio managers who came out ahead were those who took advantage of the information gap between themselves and the investing public. For example, legal insider trading was inaccessible to the everyday person, but today anyone can login to their TD Waterhouse account and presto the information is right there. As a result, PMs of today do not have the information advantage they used to making in harder to beat a mass market that is generally more informed.

Even when Warren B. was making his rounds in the beginning many people doubted his unproven abilities. Decades later we know his methodology was sound. The point being that it is impossible to select who will be the next “excellent” portfolio manager or market timer. Best bet is to invest in the collective wisdom of the market which is likely to outsmart the majority of PMs.

Michael James November 28, 2011 at 9:46 am

Your July 11th guy probably promised to say something else before he went on air. Television is in the business of saying what we want to hear. We don’t want to hear from bears at the peak of a bull market.

Peter November 28, 2011 at 10:52 am

I like the last line of the article. “You can see them again on BNN tonight”. LOL!

Oscar Vallarino November 28, 2011 at 1:45 pm

Great post Dan ! and I second Peter’s comment above !

Superior John November 28, 2011 at 4:53 pm

Great post again Dan!! Given these results would you have any faith in a hedge fund manager? Is this class of advisory investor any more savy in picking winners compared to lets say the results Dave presented?

Great info and excellent posts by the like of Chad et. al. Keep valuable topics like this and future pertinent research coming. Please!!, particularly when ‘things’ on the world market appear unstable. Level headed reports/research backed by facts keeps me from swaying too much in the market or getting an overdose of BNN.

Jon Evan November 28, 2011 at 5:38 pm

I love Blue Rodeo! But BNN is frightening and I agree completely with your analysis of the perils of unscrupulous active managers who are self serving. What villains! Yet, it is unfair to paint them all with the same brush. There are other Warren Buffets out there and some are altruistic bright gifted active managers who are able to protect investors. An investors greatest enemy is him/herself!
I understand how passive investors embrace the efficient market hypothesis and their steadfast trust of Mr. market which I find incredible to behold! Dan attributes this to temperament and I don’t disagree. I don’t trust Mr. Market because I think that human greed has corrupted it and therefore the market cannot follow normal probability theory and consequently I don’t feel safe allowing the market to determine my future investment success. Surely, as there are gifted dentists, doctors, lawyers, politicians etc. there must be gifted money managers skilled in protecting investors from Mr. Market’s corruptors! Since you live in Ontario Dan, I have been meaning to ask you if you might comment on this investment philosophy of an Ontario firm which interests me as one which seems sensible?
http://www.venablepark.com/Our_philosophy.html

Canadian Couch Potato November 28, 2011 at 6:38 pm

@Superior John: I have to admit that if I watch BNN too much some of it gives me a little self-doubt. Everyone speaks with such confidence about their “market calls,” but when you actually follow up to see how they did, they rarely look so good.

@Jon Evan: Glad we found a common interest (Blue Rodeo)! Remember that even if there are inefficiencies in the market (and I don’t doubt there are some), that doesn’t mean that market moves are predictable in advance. Buffett and other great value investors usually made their fortunes by identifying undervalued businesses and holding them for the long term, not by moving in and out of the markets.

Re: the Venable Park link you provided, I can see this service being of value to investors who take comfort in having someone manage the risk in their portfolios. I would expect that over the very long term this approach would lag a portfolio that remained fully invested all the time, but as always, that assumes you had the stomach to stay fully invested. And the fact is, many people are willing to give up some upside in order to sleep better, and there is nothing wrong with that. With a fee of 1% plus the MERs of the ETFs, the cost is very reasonable if the advice is good.

Maxwell C. November 28, 2011 at 9:18 pm

I am probably even more amazed at Jon Evan’s faith in money managers and their apparently supernatural ability to predict the future than he is in my faith in the markets. It’s a good thing that individual money managers are supposedly impervious to human greed and emotions!

Jon Evan November 29, 2011 at 12:20 am

Thanks for that assessment :).
Their advice appears realistically pragmatic to me for those whose career earning power peaks in their 40-50 age decade at a time when many are fully invested with a 60% or higher equity position. Then time horizon becomes the issue particularly if a secular bear market stretches 15-20 years. Losing 30-50% of a 60% equity portfolio will take years to repair with a buy and hold investment strategy. Only if you’re in your 20-30s could you have the stomach fortitude to persevere methinks! As far as their strategy falling short of a fully invested portfolio you need to see the graph of their results on their web site showing the exact opposite. Luck or skill I don’t know!

Canadian Couch Potato November 29, 2011 at 1:07 am

@Jon: The graph says nothing meaningful. First, the benchmark is never identified, so there is no way of knowing how appropriate it is. (It is common for investment firms to use inappropriate benchmarks to make their performance look better.) And what VenPark performance is being measured? Is there a specific fund with audited results that we can check this against? Does the blue line represent all client accounts? There are no data here at all: just two lines on a graph.

Even if we assume the comparison is appropriate, note that they underperformed the benchmark from late 2003 until mid-2008, and all the outperformance came after that. It’s worth asking if you would have been patient enough to endure 4.5 years of underperformance without bailing on their strategy. Start and end dates have a huge influence on performance reporting.

jay November 29, 2011 at 9:45 am

It really is not about timing…they work under a rules based trading…they never go all cash an even their clone funds have dif levels …some 5% others 20% but are the same fund,just dif brand name…sort of like potato chips:) As for BNN..they can’t even run a web page right.

Dale November 29, 2011 at 12:57 pm

Great idea for an article. Most money managers don’t know anything beyond the company line they are handed. When they talk about a company that I know well, I can quickly realize that they haven’t even read the company’s annual report. Most are very very lazy and not very curious. I think the ones that get it mostly work in the high net worth market.

Jon Evan November 29, 2011 at 5:36 pm

@Dan re: venablepark
Thanks again for your time to comment on the above. You are right that they are a risk management specialty firm for those with sizeable portfolios who are past the accumulation phase of investing. I did ask them about their cumulative performance and the ‘benchmark’ they are tracking is 50% XBB, 12.50% EFA, 12.5% SPY and 25% XIU.
The important advantage over buy and hold, that I see, is the remarkable lack of volatility compared to the benchmark particularly avoiding completely the 08-09 crash which must have unnerved many a buy and holder and caused them to jump ship. Though as you say they underperformed their benchmark earlier the more important point is that the portfolio performance just flattened but did not lose money which is psychologically easier to handle than what happened to buy and holders with the following crash. I suppose this is likely why someone like Mr. Pape has abandoned buy and hold as the ordinary novice investor could not hope to have the fortitude to stay invested. I know colleagues who fired their advisors with that crash and lost ~30% in one day!

Canadian Couch Potato November 29, 2011 at 7:54 pm

@Jon: I think we agree on the problem (volatility erodes returns and investors confidence), but disagree on the solution. While active managers claim to be able to turn risk on and off, market timing and tactical asset allocation are dubious ways of controlling volatility. They suggest that you can reliably capture market returns without taking a commensurate level of market risk.

A passive investor, meanwhile, simply adjusts his asset allocation to a comfortable level. Blending high-quality bonds and equities is the best way to control volatility, not guessing when to get in and out of the market.

As a general rule, you have to assume that a 50% decline in stock prices is always possible: that’s right out of Warren Buffett. So if you know you cannot stomach a 30% decline in your portfolio, then you should never have 60% in stocks, period. Anyone who abandoned their investment plan in 2008–09 was taking on more risk than they could handle. They assumed (without regard to history) that a 50% decline could not happen. I touched on this here:
http://canadiancouchpotato.com/2011/08/09/do-you-have-the-right-asset-allocation/

The benchmark portfolio that Venable Park uses on their site would have lost about 14% in 2008. That is a bad year, but anyone with a portfolio of 50% stocks had to know that it was possible. And to put that in context, it came on the heels of five strong years, and was followed by two more extremely good years. From 2001–10, that benchmark portfolio returned 5% annualized with moderate volatility. That’s not much lower than you would expect from a 50-50 portfolio over any 10-year period—and that is despite the fact that this period starts with the dot-com aftermath and includes the worst financial crisis since the Great Depression.

You mention that the Venable Park portfolio “just flattened but did not lose money.” But it absolutely lost money over several periods: it was negative from mid-2004 through the end of 2005 (a bull market, by the way), again between late 2006 and late 2007 (another bull market), and is currently lower today than it was in early 2010, judging by the chart. Clearly they made a great call to get out of the market before the crash of 2008, but as the post above shows, hardly anyone else did. So how would investors have known to trust them and not another equally accomplished portfolio manager? Should you have invested with them in early 2008? Absolutely. Did you? If not, why not? Because there was no way to identify their skill in advance.

Everyone says that they are not bothered when tactical mangers miss rallies—until it actually happens. Believe me, when everyone was making a killing between 2004 and 2007 (and again in late 2010) and Venable Park was losing money, many of their investors would not have been pleased. The same is true of the Permanent Portfolio. Funny how no one was praising its “low volatility and reliable returns” in the 1990s and mid-2000s when stocks were shooting the lights out. Every active strategy looks good during certain periods, and everyone loves a winner. If only we didn’t have to wait until the game was over to know who the winner would be.

Anyway, thanks for keeping me on my toes, and for actively participating in the debate.

Mark November 29, 2011 at 8:54 pm

Care to share the name of the guy who lives on a yacht? ;) Just curious…

Superior John November 29, 2011 at 10:38 pm

Love the banter and facts . Again as I have stated before market predicitions over the decades with a winning consistency by a fund manager, or a group of managers as John Bogle points out is akin to winning the lotto 649. Are the facts he has written about 5 years ago any different from what’s happening now? Has 100 years of market history radically changed recently with advisors/managers having a better ‘feel or system’ than their ancestors?

Dale November 30, 2011 at 6:34 am

Some managers can beat, not by timing the market, but by making macro calls and sector calls. I’ve been in the best fund in Canada for quite a while. Sprott Canadian equity. Over 20% annual returns over two decades. He knew that governments would bankrupt modern socitey but that there was lots of growth out of developing nations. He got me 60% in 2010. Gold and silver and materials. Guys like Sprott and Peter Schiff know what’s going on.

I don’t mind paying for Sprott, though I’m mostly an etf model portfolio guy.

Jon Evan November 30, 2011 at 3:53 pm

To be a passive investor I conclude that one’s temperament must be to consider volatility a mere distraction and this is the hurdle to overcome to be able to go long as a buy & hold investor. If one is volatility averse than the sol’n is allocation away from equities in order to manage this risk but of course with reduced return! To be a tactical allocation investor such as with Venable Park one must put up with missing rallies as you say but with the benefit of reduced volatility. Now Dan you were surprised that I said that Venable Park did not “lose money” and of course you are technically correct in the sense of missing the equity rally because that particular active manager was reducing their equity position concluding that the equity market was overvalued. BUT for people like myself who are no longer in the accumulation phase of investing there is a different psychology at work. What matters most is not missing rallies anymore but volatility and preservation of capital (i.e. not losing one’s initial investment) which is what Venable Park was able to accomplish with their tactical reallocation timing correctly to miss the 08 crash and thus eliminating the volatility for those allergic to it. Now looking at their results their cumulative result was to end up with a higher return between the years 03 and 11 compared to the passive benchmark. And so, the missing rally was of no significance over that term. BUT, will their success continue going forward. You are right in saying that every active manager has his successful periods and they only look good in retrospect because there are no fool proof tactical strategies which are guaranteed to work every time. Hence that is why we are not all active tactical allocation minded investors. I get it :) (I think)!

Maxwell C. December 1, 2011 at 12:58 am

@ Jon Evan:

“To be a tactical allocation investor such as with Venable Park one must put up with missing rallies as you say but with the benefit of reduced volatility.”

What I really don’t understand is wherein the benefit lies. If one misses the rallies, then the benefit of holding equities (and therefore the associated risk) in the first place is gone. If one seeks less volatility, just increase one’s bond allocation. It’s a much cheaper solution than paying someone to pull money in and out of equities. And it’s *inherently* less risky, for the risk-averse.

By missing the rallies much of the time, I think that the benefits of holding equities are negated and their volatility and payoff becomes much closer to bonds (as one is taking less risk, which will almost certainly result in less return). So the benefits of holding equities are gone, with the fees associated with paying some guy six figures a year to move one’s money around. A greater allocation to a bond index gives the same end result for probably a fraction of the cost.

What must one pay to be in this “managed allocation” thing? From what I see, the benefits don’t outweigh what is spent and the same result and benefits could be achieved MUCH cheaper otherwise :-)

Canadian Couch Potato December 1, 2011 at 8:23 am

@Maxwell C: Very well put. It is fairly easy to control volatility in a portfolio simply increasing the allocation to high-quality bonds. Of course that decreases long-term expected returns, but that is a necessary trade-off.

Jon Evan December 1, 2011 at 1:36 pm

Those who believe in evidence based research (warning: it’s easy to manipulate studies) know that most of the available finance research indicates no benefit to market timing from the various systems and trading rules proposed, but there do exist studies like by Faber titled ‘A Quantitative Approach to Tactical Asset Allocation’ or Cuthbertson titled The Market Timing Ability of UK Equity Mutual Funds’ that show that perhaps in the real world ~1.5% of active managers may be able to accomplish market timing to achieve better results than the index with the great advantage of reducing volatility which is the enemy of buy & holders because they tend to want to bail out. My case in point of Venable Park is an example whereby president Danielle Park both in her book ‘Juggling Dynamite’ and on their web site claim to be able to reduce risk by timing the market. In her book she says that it “will equip you with the tools to make your portfolio grow using active investing and market timing” and her company website illustrates this with a mysterious graph. Unfortunately, both her book and web site supply only subjective illustration without any explanation as to the methods used to time the markets to arrive at the claimed results. There is no way to examine her market timing methodology (it doesn’t appear anywhere: why?) and so one needs to accept her claim by faith. Hard to do!
After studying this extensively to decide the direction to go with my portfolio I must admit that at this juncture my own conclusion is that the average individual investor is almost certainly best off with the passive index investing of a balanced portfolio that is occasionally re-balanced and that Dan’s model portfolios allow the average DIY investor to achieve results at basement cost that are comparable to any advisor out there when one takes into consideration the costs associated with advisor expenses! The advantage of using an advisor like those that Dan recommends is important although it comes with added cost. The reason is that some of us might need an advisor to hold our hand to calm us during difficult times to prevent us from bailing out because for the DIY investor with a discount brokerage account it is way too easy to press the sell button!

Dale December 1, 2011 at 1:50 pm

Jon, which is why most retail diy investors would be better of with a 70%-80% component of balanced bond mix in their portfolios. Easier to watch a 10% decline in a meltdown than 40-50%. Chances are you’ll stick with the program.

And you don’t have to give up very much in returns with less equities.

Dale December 1, 2011 at 1:56 pm

When the tsx went down over 20%, my portfolio was within 2% of its all-time highs. Though it held lots of gold stocks that have now been liquidated.

Gold is the ultimate insurance policy as the Permanent Portfolio teaches us.

Maxwell C. December 2, 2011 at 12:05 am

“After studying this extensively to decide the direction to go with my portfolio I must admit that at this juncture my own conclusion is that the average individual investor is almost certainly best off with the passive index investing of a balanced portfolio that is occasionally re-balanced and that Dan’s model portfolios allow the average DIY investor to achieve results at basement cost that are comparable to any advisor out there when one takes into consideration the costs associated with advisor expenses! ”

Wow. I never thought I would have heard it. Good job Jon! ;-P

InsureCan December 2, 2011 at 9:37 am

Very interesting point that some advisors can plan defensively but are late to the recovery party.

I have a friend in the US with a good chunk of client money under management. He looked like an absolute hero when he moved everyone over to mostly cash just prior to the crash (he got a lot of recommendations out of that). But as he said, “I can pick the top, but I can’t pick the bottom”. Great on the defence, no so much on the offence.

But in the end, that’s why passive investing works best – even if you pick the top, you won’t pick the bottom, so you’ll lose in the end. Passive investors should know that markets don’t recover linearly – they recover all at once, in one day. You wake up and it’s recovered. Not already there? Too late.

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