All About Market Timing 2nd Edition

THE EASY WAY TO GET STARTED

By LESLIE N. MASONSON

The McGraw-Hill Companies, Inc.

Copyright ©2011 Leslie N. Masonson
All rights reserved.
ISBN: 978-0-07-175377-7

Contents

ForewordAcknowledgmentsIntroductionPART 1: MARKET TIMING BASICSChapter 1 The Stock Market = Bull Markets + Bear MarketsChapter 2 The Buy-and-Hold MythChapter 3 Market Timing: What You Need to KnowChapter 4 Determing the Market’s TrendChapter 5 No-Load Mutual Funds: Index, Sector, and Leveraged FundsChapter 6 Exchange-Traded FundsPART 2: MARKET TIMING STRATEGIES AND RESOURCESChapter 7 Calendar-Based Investing: The Best Six Months StrategyChapter 8 Combining Presidential Cycle Years with SeasonalityChapter 9 Using Simple Moving Averages to Time the MarketChapter 10 The Value Line 4 Percent Strategy versus the Value Line 3
Percent StrategyChapter 11 Nasdaq Composite 6 Percent StrategyChapter 12 Market Timing Resources: Newsletters, Web Sites, and AdvisorsEpilogueAppendix: The Capitalism DistributionBibliography and Web SitesIndex

Excerpt

CHAPTER 1

The Stock Market = Bull Markets + Bear Markets

The first rule is not to lose. The second rule is not to forget the firstrule.

—Warren Buffett

In the battlefield that is the stock market, there are the quick and thereare the dead! … The fastest way to take a bath in the stock market is to tryto prove that you are right and the market is wrong.

—William J. O’Neil (How to MakeMoney in Stocks, 2002, p. 54)

ING DIRECT SHAREHOLDER SURVEY

Before covering the stock market’s performance in bull and bear markets, let’sfirst begin by reviewing the results of a survey of 1,021 young (ages 21 to 39years) and old (ages 40 to 65 years) investors conducted by ING DIRECT to obtaintheir views about investing in the stock market. The study was conducted onlinefrom January 7 to 19, 2010, ten months after the market bottomed in March 2009.The survey questioned these investors on the following subjects: confidence andoptimism, influencers, motives, barriers, and expected returns.

The key survey findings were as follows:

* 43 percent of those 21 to 39 years of age plan to invest more in 2010 comparedwith 33 percent of those 40 to 65 years of age.

* 26 percent of younger investors and 28 percent of older investors expect anannual return of between 10 and 20 percent.

* Older investors are leading the trend to become self-directed investors.Almost half (49 percent) of those 40 to 65 years of age have reduced oreliminated their reliance on financial professionals compared with 37 percent ofinvestors aged 21 to 39 years.

* Younger investors currently rely more on financial Web sites and blogs (49percent) and financial print publications (39 percent) than on financialplanners or advisors (35 percent) or brokers (18 percent) for investing advice.

* Investors aged 40 years and older also rely more on financial Web sites andblogs (47 percent) and financial print publications (41 percent) than onplanners or advisors (39 percent), brokers (36 percent), and family (19percent).

* On average, investors think that they need $699 to get started investing.

* Almost half (48 percent) of younger investors think that they need more than$500 to start investing compared with 56 percent of older investors.

* Almost half (44 percent) of those with access to an automated platform thatenables investing in small dollar amounts say that you can get started with just$100 or less.

* Almost one-third (30 percent) of the younger group say that their parents hadthe biggest influence in getting them started investing.

* 17 percent of investors 40 to 65 years of age say that their parents had thelargest influence in getting them started investing.

* 81 percent of respondents who own a brokerage account and who are fullyemployed have a retirement account:

* 34 percent are between 35 and 44 years of age, whereas 77 percent of thosewith no 401(k) account are older or younger than Generation X.

* 47 percent earn at least $125,000 annually, compared with just 25 percentamong those who do not own a 401(k).

* 56 percent have at least a college degree or more education compared with 41percent among those who do not own a 401(k).

* Over half (52 percent) of investors plan to invest about the same amount in2010 as they did in 2009, and surprisingly, about 4 out of 10 (37 percent) planto invest more.

* Just 11 percent say that they plan to invest less in 2010.

* Younger investors are even more optimistic. Forty-three percent of those 21 to39 years of age plan to invest more in 2010 compared with 33 percent of those 40to 65 years of age.

* More than 6 in 10 (63 percent) either plan to make no changes in theirapproach or plan to take a more aggressive approach to what they perceive as abuying opportunity.

* 22 percent say, “I think now is a great time to invest. I’m taking a moreaggressive approach.”

* Another 41 percent say, “I believe in a long-term view when it comes toinvesting, so I’m not making any changes to my investments.”

* Just 5 percent indicate they have headed to the sideline with their choice ofthe statement, “It’s too risky. I don’t want to invest right now.” Thirty-onepercent say, “I’m more conservative than before, but it’s still okay to invest.”

* .61 percent of investors expect an annual return of between 5 and 10 percenton their money.

* 26 percent of younger investors and 28 percent of older investors expect anannual return of between 10 and 20 percent. The weighted-average return is 11percent, considering all responses.

* 45 percent of investors have either reduced or eliminated their use offinancial professionals for investing advice. Older investors are leading thistrend. Almost half (49 percent) of those 40 to 65 years of age have reduced oreliminated their reliance compared with 37 percent of investors aged 21 to 39years.

* 62 percent of younger investors indicate that the cost of advice was thereason they reduced or eliminated their reliance on financial professionals forinvesting advice. By comparison, 57 percent of investors 40 to 65 years of agefeel that they can do just as good a job on their own.

* Family members (40 percent) are being used by more young investors for advicethan brokers (18 percent). Investors aged 40 years and older also rely onfinancial Web sites and blogs (47 percent) and financial print publications (41percent) more than planners (39 percent), brokers (36 percent), and family (19percent).

SURVEY OF AFFLUENT INVESTORS INDICATES CONCERNS

Let’s look at another survey of investors that focuses only on more affluentinvestors. Merrill Lynch Affluent Insights Quarterly Survey results were basedon interviews with 1,000 affluent investors with investable assets of at least$250,000 on June 11 and 29, 2010, and another 300 Americans in each of 14 targetmarkets. The source of this information is a Bank of America press release datedJuly 28, 2010, sent over Business Wire.

The key findings of their survey are as follows:

* 70 percent of those surveyed do not believe that their retirement plans takeinto account the potential for unexpected family events (e.g., serious illness,divorce, caring for parents), but 35 percent have adjusted their prioritiesaccordingly.

* 51 percent of couples disagree with each other on making investment decisions,how best to save and invest for retirement, sticking to family’s budget, andpaying off credit-card debt.

* 51 percent cited “financial know-how” when asked about important life lessonsto impart to their children.

* 39 percent of parents were spending more time discussing financial matterswith their children in light of current economic conditions.

* 74 percent of parents shared advice from their financial advisor to educatetheir children.

* 50 percent of respondents had a low risk tolerance and used conservativeinvestment vehicles and strategies; this compares with 52 percent of youngerpersons (ages 18 to 34 years), who have a similar risk tolerance; 45 percent for35- to 50-year-olds; 46 percent for 51- to 64-year-olds; and 55 percent forthose age 65+.

* Both younger and affluent individuals (56 and 46 percent, respectively) aremore conservative investors now than one year earlier.

* 45 percent of respondents are planning to delay their retirement compared with29 percent in January 2010.

* 69 percent of the affluent want their financial advisor to be proactive withinvestment advice, and 68 percent want advice on how to maximize their 401(k).

STOCK MARKET REALITY AND FORECASTS

In March 2000 and October 2007, investors had no idea that the next two to threeperiods would result in two horrendous bear markets. Just look at the massivedevastation inflicted on investors during that combined period, where a total of$14 trillion in market value was erased in only 32 months from peak to trough inthe 2000–2002 crash and in only 17 months in the 2007–2009 crash.The last crash has been the worst in percentage terms since the GreatDepression.

During 1999 and 2000, the stock market and especially the “hot” Internet stockswere the topics of conversation at supermarkets, bowling alleys, bars, and hairsalons all across America as the market soared to unprecedented heights. CNBCreplaced the “soaps” as the most popular daytime entertainment medium, with itsstreaming stock quotes and never-ending procession of bullish marketstrategists, bullish financial analysts, and bullish CEOs.

Euphoria was in the air, and life was great for millions of retirees and regularfolks who had started investing over the past 20 years, and especially daytraders, who were racking up huge gains as stocks advanced day after day. Thatall came to a screeching halt, though, when the big bear started growling inApril 2000, when the Nasdaq Composite dropped a jaw-dropping 25.3 percent duringthe week of April 14. The bear then unceremoniously clawed the marketover the next few years.

The market’s upswing finally began in October 2002, but there was another dropinto March 2003 before the market started its slow rise to a recovery peak inOctober 2007, only to crash again to new lows by March 2009. At that point, ahuge rally took place, vaulting the market by 90 percent from those lows byDecember 2010.

Many investors were so scared by the two most recent bear markets that they didnot participate in the market’s rise from the March 2009 lows; as they did notput money into equities but rather concentrated on building their cash and bondpositions. Such a conservative approach allowed them to sleep better at nightbut cost them big gains, which don’t come along very often.

INVESTORS ARE TOO EMOTIONAL AND OVERCONFIDENT

Whether you believe it or not, the stock market is a very difficult place toconsistently make money unless you have a strategy that works. This is not a newthought. Over the past 100 years, the stock market has been punctuated by sharp,uplifting bull markets, followed by swiftly plummeting bear markets. This cyclehas happened in the past, and it will happen in the future—for, after all,the markets are driven by people’s emotions and actions. Market cycles repeatthemselves, just as history repeats itself. People are people, and where moneyis at stake, people react emotionally, which usually results in bad decisionmaking. Investors have a poor track record of making money in the stock market.

Numerous surveys have shown that investors buy and sell at the wrong times, andthey usually buy and sell the wrong investments at the wrong times. Behavioralresearchers have found that the incorrect decisions that investors are prone tomake are the result of overconfidence in their investment knowledge,overtrading, lack of diversification, and incorrect forecasting of future eventsbased on recent history. Stock market success requires that investors actindependently of the crowd and rein in their emotions. If fear and greed are noteliminated from the investing equation, the results can be catastrophic.Unfortunately, investors will continue to make the same mistakes over and overagain. This is just the way it is.

Robert Safian in a January 2003 Money magazine article said: “All acrossAmerica, millions of people are afraid to open their account statements, afraidto look at their 401(k) balances—afraid to find out what they’ve lostduring this long bear market and where they stand today.” This is a pretty sadstate of affairs. However, it did not have to be that way if investors wouldonly have had an investment plan that forced them to take profits as stocks keptgoing up, and they had placed stop-loss orders on their stocks to protect theirpositions as prices collapsed. But most investors froze and did nothing untilthe market was well off its highs. Then, as the market hit subsequent lows inJuly and October 2002, investors took their billions of dollars out of equitymutual funds and began investing their money in bonds and money-market funds.Other investors just gave up and cashed in all their investments, having enduredsevere emotional and financial pain.

The vast majority of individuals are not savvy investors, even though many haveabove-average intelligence and consider themselves to be above-averageinvestors. They do not have the time, background, or expertise to assess themarket at key turning points (e.g., whether the bull market is beginning orending). Moreover, the average investor’s performance typically is worse thanthe appropriate market benchmark or even the actual performance of his or hermutual funds. This outcome is a result of poor timing on entry and exit pointsand lack of a coherent, well-researched strategy. Most investors buy and sell ona whim, or they take advice from a friend or CNBC, or they act based on hearingan “expert” giving his or her opinion on the market or a particular mutual fundor stock in the media.

Investors need a methodology to know when to buy and sell, but only a fewinvestors have even thought about it, let alone have a methodology in place.Unfortunately, investors as a group invest and hope for the best. This approachis no way to build a nest egg for the future but rather is a recipe forfinancial disaster. You wouldn’t leave your garden untended because you knowthat weeds will grow and kill your flowers and vegetables. The same logicapplies to your investments. Being proactive is better than being nonactive.This is not to say that you should be an active trader or an aggressive investorbut rather that investing is not a static endeavor. You should watch over yourinvestments, making adjustments as necessary to weed out the dead wood andreplacing it with more fruitful pickings. You are the best gardener for yourinvestment patch. Don’t let the experts tell you otherwise.

Just because you bought shares in high-quality companies doesn’t mean that youmade smart investments. Even the so-called blue chips had plummeted from their2007 highs to much lower levels by March 2009. General Electric went from $42 to$6, Goldman Sachs went from $250 to $46, and AIG hit $1,400 before dropping to$0.35 (both prices split-adjusted). This type of devastation doesn’t have tohappen to you if you become a smarter investor going forward. Surely, by heedingthe advice of the Wall Street intelligentsia, you can come out way ahead, right?Wrong!

MARKET SEERS ARE AN EMBARRASSING LOT

If you ask five experts where to invest, there will be six answers: the fiveexpert opinions, plus the right one.

—Jonathan Clements, “Need One ExpertOpinion on Investing? Here’s Five,”Wall Street Journal, January 4, 2000

Think about all the stock market experts’ market predictions you’ve read orheard about over the past few years. A handful of these characters have been letgo or have changed firms. Even some well-known technicians do not have very goodtrack records calling the market top. BusinessWeek published a year-endreview for each year from 1999 through 2002 showing the market predictions ofstock market experts for the upcoming year. In all the years, the experts had apoor track record because most were bullish, and their projections of themarket’s performance were way off. I haven’t seen any surveys like this in thepast few years. I wonder why?

BusinessWeek also published a list of the experts’ individualpredictions in its year-end issue. The number of prognosticators tracked by themagazine for the years 2000 through 2003 has varied between 38 to 65, with 50being the average. This list represented a solid cross section of well-knownmarket strategists at that time, including Joseph V. Battipaglia, ElaineGarzarelli, Edward Yardeni, Bernie Schaeffer, Edward Kerschner, Lazlo Birinyi,Jr., Hugh Johnson, Philip J. Orlando, and Jeffrey Applegate.

Table 1-1 shows the composite results of all their forecasts over fouryears for the Dow Jones Industrial Average (DJIA), the Standard & Poor’s 500Index (S&P 500), and the Nasdaq Composite Index. The table delineates for eachyear the high, low, and consensus forecast of all the forecasters for each ofthe three popular market averages. As you can see, starting with the firstforecast for the 2000 stock market made at the end of 1999, the forecasters hada poor record. In fact, in each of the last three years their forecasts havegotten progressively worse. Forecasters, as a group, were simply overlyoptimistic. There are always a few bears around, but even the bears did notpredict the actual lows of the market in 2002. The most inaccurate predictionswere for the Nasdaq; the actual close compared with the consensus forecasts wasoff by 54 percent in 2000, 84 percent in 2001, and 67 percent in 2002. Inconclusion, the “best and the brightest” appeared to be not so bright or right.To be fair, their actual stock picks for their clients could have been quitedifferent and perhaps closer to the mark. For the sake of their clients, I hopethat was the case.

(Continues…)
(Continues…)Excerpted from All About Market Timing 2nd Edition by LESLIE N. MASONSON. Copyright © 2011 by Leslie N. Masonson. Excerpted by permission of The McGraw-Hill Companies, Inc..
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