Stock Market Top Appears In (9 months in, and 750 points lower.)

[techboy]

I guess we'll see if you're luckier this time than in this thread, when immediately after proclaiming a Dr. McHugh's "100% track record" (and taunting us in advance that we needed to get our "random market excuses" ready), your predicitons based on his work went 0 for 2 in 2 days, at which time you disappeared, or this thread, which had dramatic predictions and ultimately nothing but excuses. You let that thread die too, oddly enough.

But hey... maybe it'll come up heads this time. Keep your chin up!

Oh, and since I'm going to post it sooner or later, I'll just do it now. This is what the actual hard data says about market timing:

The research overwhelmingly shows that market timing usually isn't going to get you anything but higher costs and lower returns.

Here's a good piece by Burton Malkiel, professor of economics at Princeton: Keep Your Money in the Market An excerpt:

It is very tempting to try to time the market. We all have 20/20 hindsight. It is clear that selling stocks a year ago would have been an excellent strategy. But neither individuals nor investment professionals can consistently time the market. The herd instinct is extraordinarily powerful. When the economy and the stock market were booming in early 2000, investors could easily convince themselves that prosperity would continue without interruption and that stocks catering to the "New Economy" were surefire tickets to wealth. Individuals poured more money into equity mutual-funds during the last quarter of 1999 and the first quarter of 2000 than ever before. And not only was the timing wrong but so was the selection of funds. The money flow was directed to the hot Internet funds. Investors liquidated "value" funds that owned less exciting businesses, whose stocks sold at only modest multiples of their earnings and book values.

The herd instinct works exactly the same way in bear markets. Nervous investors convince themselves that every "light at the end of the tunnel" is a train coming in the opposite direction. Panic is just as infectious as blind optimism. During the third quarter of 2002, which turned out to be the bottom of a punishing bear market, investors redeemed their mutual funds in droves. My own calculations show that in the aggregate, investors who moved money in and out of equity mutual-funds underperformed the buy-and-hold investors by almost three percentage points per year during the 1995-2007 period.

Emphasis mine.

Or, let's look at what David Swensen, himself a professor at Yale and manager of their uber-successful endowment has to say about it...

Swensen manages Yale University's endowment. Last year, he made a 28 percent return, adding a whopping $5 billion to Yale's endowment, which is now valued at $22 billion. And that wasn't a fluke: Over the past two decades, under Swensen's watch, Yale's endowment has grown an average of 16.8 percent a year, more than any university, foundation or pension fund.

In scary economic times like this, he cautions that individual investors shouldn't trust their instincts.

"The human tendency in this kind of environment is to do something — to make a change," he says.

Stocks seem risky, especially since they've been falling. Swensen says most people he talks to get nervous and want to sell stocks.

"And that's exactly the wrong reaction," he says. "Buying high and selling low is not a way to make money. It's not hard, right? It's very simple: You want to do the opposite."

Oh, well he's probably talking about amateurs, right? Surely the pros can manage it... Let's look at The Difficulty of Selecting Superior Mutual Fund Performance. The abstract:

-Much has been written about the management of mutual funds and active versus passive management. This study attempts to quantify the relative performance of actively managed large- and mid-cap domestic stock mutual funds with a passive strategy during a 20-year period, including 11 10-year rolling periods.

-During the study period, most actively managed large- and mid-cap mutual funds underperformed their respective passive strategies. While every period under review had mutual funds that outperformed the passive strategy, few funds did so consistently.

-Furthermore, predicting in advance which mutual funds would outperform was difficult, if not impossible, and the cost of selecting the "wrong" manager was high. These factors combined demonstrate the difficulty for financial planners to select superior performance.

-The study also reviewed the impact of taxes on large-cap investments.

Finally, the author provides recommendations for financial planners in discussing action steps regarding clients' portfolios.

Emphasis mine. Hey... if the pros can consistently time the market, why don't any of them produce consistently predicatable results?

Let's ask Professor Malkiel, who wrote a paper entitled The Efficient Market Hypothesis and its Critics. I'll just quote the introduction:

A generation ago, the efficient market hypothesis was widely accepted by academic financial economists; for example, see Eugene Fama’s (1970) influential survey article, “Efficient Capital Markets.” It was generally believed that securities markets were extremely efficient in reflecting information about individual stocks and about the stock market as a whole. The accepted view was that when information arises, the news spreads very quickly and is incorporated into the prices of securities without delay. Thus, neither technical analysis, which is the study of past stock prices in an attempt to predict future prices, nor even fundamental analysis, which is the analysis of financial information such as company earnings, asset values, etc., to help investors select “undervalued” stocks, would enable an investor to achieve returns greater than those that could be obtained by holding a randomly selected portfolio of individual stocks with comparable risk.

The efficient market hypothesis is associated with the idea of a “random walk,” which is a term loosely used in the finance literature to characterize a price series where all subsequent price changes represent random departures from previous prices. The logic of the random walk idea is that if the flow of information is unimpeded and information is immediately reflected in stock prices, then tomorrow’s price change will reflect only tomorrow’s news and will be independent of the price changes today. But news is by definition unpredictable and, thus, resulting price changes must be unpredictable and random. As a result, prices fully reflect all known information, and even uninformed investors buying a diversified portfolio at the tableau of prices given by the market will obtain a rate of return as generous as that achieved by the experts.

The way I put it in my book, A Random Walk Down Wall Street, first published in 1973, a blindfolded chimpanzee throwing darts at the Wall Street Journal could select a portfolio that would do as well as the experts. Of course, the advice was not literally to throw darts but instead to throw a towel over the stock pages – that is, to buy a broad-based index fund that bought and held all the stocks in the market and that charged very low expenses.

By the start of the twenty-first century, the intellectual dominance of the efficient market hypothesis had become far less universal. Many financial economists and statisticians began to believe that stock prices are at least partially predictable. A new breed of economists emphasized psychological and behavioral elements of stock-price determination, and came to believe that future stock prices are somewhat predictable on the basis of past stock price patterns as well as certain “fundamental” valuation metrics.

Moreover, many of these economists were even making the far more controversial claim that these predictable patterns enable investors to earn excess risk-adjusted rates of return.

This paper examines the attacks on the efficient market hypothesis and the belief that stock prices are partially predictable. While I make no attempt to present a complete survey of the purported regularities or anomalies in the stock market, I will describe the major statistical findings as well as their behavioral underpinnings, where relevant, and also examine the relationship between predictability and efficiency. I will also describe the major arguments of those who believe that markets are often irrational by analyzing the “crash of 1987,” the “Internet bubble” of the fin de siecle, and other specific irrationalities often mentioned by critics of efficiency. I conclude that our stock markets are far more efficient and far less predictable than some recent academic papers would have us believe. Moreover, the evidence is overwhelming that whatever anomalous behavior of stock prices may exist, it does not create a portfolio trading opportunity that enables investors to earn extraordinary risk adjusted returns.

Emphases mine.

Warren Buffet put it this way in a recent op-ed:

Let me be clear on one point: I can’t predict the short-term movements of the stock market. I haven’t the faintest idea as to whether stocks will be higher or lower a month — or a year — from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up. So if you wait for the robins, spring will be over.

Or, here's a popular press article from William J. Bernstein, Why stock picking is a losing game. Two excerpts:

Imagine that the Man Upstairs is really, really pleased with you and has decided to make you fabulously wealthy. How would He do it? The simplest way would be to give you a bunch of no-brainer opportunities to make a killing on stocks and bonds. Then He'd put on this earth a host of suckers willing to take the opposite side of your bets.

Millions of investors - and their brokers - seem to believe their own personal version of this fantasy. Because whenever somebody tells you he has found a simple strategy for beating the market, what he's really saying is that the market, apart from him, is populated by patsies.

Consider, for example, newsletters with ranking systems that tell you when it's time to buy or sell a stock. You aren't the only one who can pad down to the library or click online to look up the latest ratings. If the newsletters worked, what rube would be willing to part with a stock rated "buy" and sell it to you? And who would buy it back from you when the mighty oracle pronounced a sell rating? (The newsletter writer must also be pretty clueless to be selling this priceless knowledge to total strangers for a few hundred bucks.)

Sometimes you'll spot an opportunity for a trade that seems screamingly obvious - and that's exactly when you'd better stop to ask yourself what's wrong with it.

The best way to win this game is to not play it. Stick with low-expense index funds - under 0.2% in annual charges - that simply own all of the market, both in the U.S. and abroad.

I'm sure you've heard that while it's fine to ride the market's gains when times are good, you need an expert stock picker when the bear roars. Wrong: Active money managers do not suddenly gain an extra 20 IQ point advantage over the rest of the market just because the Dow is falling. The record shows that their funds have trouble competing with the index in the bad times too.

Finally, always remember what your father told you about playing poker: If you look around the table and don't see a patsy, then you're the patsy.

So how should we invest, knowing all that? More Buffet...

"The best way in my view is to just buy a low-cost index fund and keep buying it regularly over time, because you'll be buying into a wonderful industry, which in effect is all of American industry," Buffett told CNBC anchor Liz Claman.

and

"I have nothing against ETFs, but I really think an index fund that just charges a few basis points for management is pretty hard to beat," Buffett said. "You put it away, you have nobody encouraging you to trade it next week or next month ... your broker isn't going to be on you."

and

Numerous academic studies have shown that individual investors have a bad track record at timing stock-market moves, often because they chase recent performance to their detriment, essentially buying high and selling low.

But you want to talk hard data, let's look at this. From How to lose $9 trillion in a bull market: That's what bad timing cost investors over the past 25 years. But you can learn to avoid a similar fate, by Jason Zweig. Excerpts:

An inconvenient truth

An accounting professor at the University of Michigan named Ilia Dichev has cracked the case, and his findings, published recently in the prestigious American Economic Review, have huge implications for how you should invest.

I've written before about the gap between the returns reported by mutual funds and the money earned by their investors. Reported returns almost always look better than investor returns because people pile in after a fund gets hot and then sell or freeze after it's gone cold.

What Dichev's research shows is that the same thing holds true for the stock market as a whole.

By looking at how much money was flowing into publicly traded companies through initial and secondary stock sales and how much was flowing out via dividends, buybacks and buyouts, Dichev was able to measure the return on the typical invested dollar.

So what about that $9.5 trillion? "The money did not disappear," says Dichev. "It was never there in the first place." In other words, reported long-term returns aren't historical, they're hypothetical.

The U.S. stock market was never worth $28 trillion. That 13.3 percent "average" return was only for a strict buy-and-hold investor, a description that hardly applies to the big institutional players that move the stock market.

Consider that between 1973 and 2002, Nasdaq stocks gained an annual average of 9.6 percent. But that assumes money was invested on Jan. 2, 1973 and stayed put until Dec. 31, 2002 (with no taxes paid on the gains).

In reality, because investors pumped $1.1 trillion into Nasdaq stock offerings between 1998 and 2000 - just before the worst crash in modern history - the typical dollar invested in the Nasdaq earned only 4.3 percent a year, less than half the historical return.

Anyway, here's the paper, with free pdf download.

The abstract:

Abstract: The existing literature typically does not differentiate between security returns and the returns of investors in these securities; usually implicitly, these two concepts are assumed to be the same. However, the returns of stock investors depend not only on the returns of the securities they hold but also on the timing of their capital flows into and out of these securities. This paper suggests a new and more accurate measure of stock investors’ historical returns, which involves dollar-weighting of the returns and properly reflects the effect of investors’ timing. Theoretically, the essence of dollar-weighted returns is that they value-weight both the cross-section and the time-series of returns. In practical terms, dollar-weighted returns are computed as internal rate of returns (IRRs) from investment projects in which initial market values and contributions from investors (e.g., stock issues) enter with negative signs, and distributions to investors (e.g., dividends, stock repurchases) and final market values enter with positive signs. The empirical results indicate that aggregate dollar-weighted returns are systematically lower than buy-and hold returns. The annual difference is 1.3 percent for the NYSE/AMEX market over 1926-2002, 5.3 percent for Nasdaq over 1973-2002, and averages 1.5 percent for 19 major stock markets around the world over 1973-2004. Thus, this study provides comprehensive evidence that stock investors’ actual returns are considerably lower than those from passive holdings and from those documented in the existing literature on historical stock returns. These results have implications for the debate on the equity premium, for the literature on long-run returns following capital flows, for building successful investment strategies, and others.

Emphasis mine. Some other excerpts:

These results have a number of implications. The most obvious one is that stock investors’ actual historical returns are lower than existing estimates based on buy-and-hold specifications.

For example, the annualized buy-and-hold return on Cisco’s stock since the initial public offering in 1990 until the end of 2002 is 48.7 percent, indicating a truly extraordinary performance. However, Cisco’s dollar-weighted return over this period is only 11.7 percent.

For example, one puzzling finding in

the existing literature is that most investment managers underperform the market (measured as buy-and-hold returns), which questions the value-added of professional investment management.

Again, this study's period covers exactly when, if market timing worked, it should have. It's about the worst scenario one can imagine for buy and hold: it starts right before the worst Bear Market in ages, so the "hold" held it down 50%, and it ends right after another horrible drop in 2002 (tech bubble pop plus 9/11). And yet buy and hold still outperformed.

Nine and one half trillion data points say market timing is the wrong approach.

[techboy]

Prudent investing would suggest that simple stop-losses be entered.

Pick a % amount. 5%, 10%. Whatever amount of a drop that you are comfortable sustaining.

If the market drops that %, then take the appropriate action. It isn't difficult.

If I am totally incorrect, and the market just continues higher, you are still invested.

The problem with this approach is that you also have to guess about when to get back in. Do you wait until it's higher than when you sold? Then you do lose money for real (not paper losses).

All that jumping in and out is why Dichev (and other academics) repeatedly find that actual return for investors is far lower than it should be, theoretically.

[McD5]

Good luck with all of that techboy.

Buy-and-hold has been epic fail over the last ten years.

And this time will be no different.

We'll check back in a few months, and see how things are shaping up.

[techboy]

Buy-and-hold has been epic fail over the last ten years.

That's a myth. Why Your Portfolio Should Be Near an All Time High:

2007 ended in the fifth strait bull year where U.S. stocks nearly doubled and international stocks tripled. Most of us (including me), had no idea that on the horizon lurked the biggest and fastest bear market to hit the U.S. since the great depression.

The stock market has rebounded greatly, but indexes are still far below their levels at the end of 2007. So how much should your portfolio be down? Disregard the doom and gloom that you’ve probably read, because I’m going to argue that this grizzly-sized bear market should have resulted in you only losing 6 percent of your portfolio. And to illustrate why I think so, let’s use a moderate portfolio I define as 60 percent equities (two-thirds US) and 40% bonds.

Of course, you'd have to be disciplined, buy, hold, and rebalance.

And, of course, no "buy and hold" strategy is for only 10 years.

What's more, the research is conclusive, as bad as buy and hold is, market timing is worse.

[McD5]

The problem with this approach is that you also have to guess about when to get back in. Do you wait until it's higher than when you sold? Then you do lose money for real (not paper losses).

All that jumping in and out is why Dichev (and other academics) repeatedly find that actual return for investors is far lower than it should be, theoretically.

It really isn't that difficult.

For ease, let's say the dow is at 10,000 even.

You are 55 years old. You hope to retire soon.

Your comfort level, or max-pain level is a 5% loss on your stock portfolio.

If the Dow drops to 9,500, you sell.

There is no rush to get back in the next day.

You will only want to buy again after a severe decline, or when the market is higher than when you sold, and is showing strength again.

[techboy]

You are 55 years old. You hope to retire soon.

If you're 55 and hope to retire soon, you're a nutcase if you have money you need in the next 10 to 20 years in the stock market, "stop loss" or not.

[TD_washingtonredskins]

Should I really be reacting to these types of things if I have 25+ years before I can even think about retiring? Isn't a long-term investment supposed to ultimately weather the storm and make you money in the LONG-RUN?

[McD5]

That's a myth. Why Your Portfolio Should Be Near an All Time High:

Of course, you'd have to be disciplined, buy, hold, and rebalance.

And, of course, no "buy and hold" strategy is for only 10 years.

What's more, the research is conclusive, as bad as buy and hold is, market timing is worse.

If you are 55, deciding whether to invest funds now, and hoping to retire within ten years, then the next ten years is extremely important.

We'll check back in a few weeks, months, whatever.

I say the year high was yesterday. To the exact day.

And the following drop will be brutal.

After we see what happens, then we can discuss again which strategy was better.

[techboy]

Should I really be reacting to these types of things if I have 25+ years before I can even think about retiring?

No.

Isn't a long-term investment supposed to ultimately weather the storm and make you money in the LONG-RUN?

Yes! Bouncing around now just adds unneeded costs (like to the tune of 9 and one half trillion dollars).

[McD5]

If you're 55 and hope to retire soon, you're a nutcase if you have money you need in the next 10 to 20 years in the stock market, "stop loss" or not.

You absolutely have to have money in the stock market in that case.

Cds and fixed income don't cut it these days.

They don't generate enough income, and people are living longer than they planned for.

You absolutely have to be invested in stocks.

[techboy]

After we see what happens, then we can discuss again which strategy was better.

We can discuss your prediction on January 1, 2011. We can discuss my strategy and how it worked in like 30 years.

Hope we're both still around, hopefully having many more Super Bowl victories to discuss between now and then.

[techboy]

They don't generate enough income, and people are living longer than they planned for.

Notice that I said "money you need in the next 10 to 20 years". Money for when you're 75 to 80 can (and should, probably), still be in stocks.

The money you have to have though, shouldn't be. Far too risky.

[zoony]

I am predicting a correction as well over the coming months. I think 2010 will be relatively flat. I think the market will finish up the year between 10500 and 11k after a few peaks and valleys along the way.

However, I really don't think we'll see anything close to 6500. That's crazy.

If anyone is looking for a good short term strategy in stocks (1-2 years) I would suggest picking stocks that pay good dividends. CD's aren't paying jack-**** right now, so a stock with a high credit rating that pays 3% or so is actually a pretty good bet.

[Destino]

Yes! Bouncing around now just adds unneeded costs (like to the tune of 9 and one half trillion dollars).

Sure... assuming you didn't plan your retirement party in the middle of a massive stock market crash that you would have no way to see coming. Most of the research you are posting is on information prior to this crash. They write off impossible to avoid crashes by saying "well you should have rebalanced" after telling you to hold.

Ultimately buy and hold is market timing. The only difference is you are timing your exit blindly and if you happened to turn 65 one year ago, you lose. You get rolled up into an "average" and on average the people that retired the 7 years previous to you outnumber you and the dart board strategy lives on.

[McD5]

Notice that I said "money you need in the next 10 to 20 years". Money for when you're 75 to 80 can (and should, probably), still be in stocks.

The money you have to have though, shouldn't be. Far too risky.

That makes no sense.

65 yr old.

Has 200k.

Cds are a joke. Their only option is to invest in high-dividend ets for example.

And yes, they need that money.

[zoony]

Ultimately buy and hold is market timing. The only difference is you are timing your exit blindly and if you happened to turn 65 one year ago, you lose. You get rolled up into an "average" and on average the people that retired the 7 years previous to you outnumber you and the dart board strategy lives on.

I think the point is that as you approach the age of 65 you are slowly ratcheting down your participation in the market and investing more in treasuries and other static returns.

You don't wait until you are 65 and then sell all of your stocks.

[techboy]

Most of the research you are posting is on information prior to this crash.

The research includes periods that are as bad, or worse, than this last one, like the 1970s.

What's more, the article I just posted shows how a simple 60/40 buy and hold portfolio is down just 6%.

That's the key. You should never have money you need in the next 10-20 years in stocks, so even if you do retire into a period like this, you still have what you need in other safer assets, like bonds, and your stocks have time to recover.

And again, market timing won't save you (unless you're lucky). On average, you'll do worse.

Of course, 90% of people seem to think that they are above average drivers.

[NattyLight]

I was going to waif until 11k, but I think I'm going to dump everything into bonds soon. I really got burned in 2008. Thanks.for the heads up mcd.

[zoony]

I was going to waif until 11k, but I think I'm going to dump everything into bonds soon. I really got burned in 2008. Thanks.for the heads up mcd.

I don't think that's a good strategy. Interest rates will be rising soon, and your bonds will be de-valued.

I think in a couple of years when the FED has jacked interest rates to temper inflation during the economic recovery, bonds are going to be a great buy.

.....

[Popeman38]

I think the point is that as you approach the age of 65 you are slowly ratcheting down your participation in the market and investing more in treasuries and other static returns.

You don't wait until you are 65 and then sell all of your stocks.

Thank you! Stock heavy early while you have time to recover and as you age you slowly start getting more conservative.

[techboy]

I think the point is that as you approach the age of 65 you are slowly ratcheting down your participation in the market and investing more in treasuries and other static returns.

You don't wait until you are 65 and then sell all of your stocks.

Precisely. Stocks are too risky for money you'll need in the next 10-20 years, especially for retirement.

It's true that treasuries are paying pretty poorly right now, but TIPS at least keep you up with inflation, and you don't risk it.

If you need stock-like returns to retire, you're probably safer working a few more years, unless you like dog food.

[Destino]

The research includes periods that are as bad, or worse, than this last one, like the 1970s.

What's more, the article I just posted shows how a simple 60/40 buy and hold portfolio is down just 6%.

That's the key. You should never have money you need in the next 10-20 years in stocks, so even if you do retire into a period like this, you still have what you need in other safer assets, like bonds, and your stocks have time to recover.

And again, market timing won't save you (unless you're lucky). On average, you'll do worse.

Of course, 90% of people seem to think that they are above average drivers.

The article you posted is a joke. Even the writer includes this to cover his obvious laugh of an article:

Sadly, most people lost far more than five percent over the two year period. Just looking at 2008, average mutual fund equity returns were about two percentage points lower than the index funds. The average taxable bond fund returned a whopping thirteen percentage points less than the total bond fund. And rebalancing back to 60 percent equities in the beginning of 2009 wasn’t something investors, or most advisers, had the stomach to do.

He's using hindsight and he acknowledges that most people wouldn't have made this decision at the time and most lost significantly more than that small percentage.

My question is this... if you did in fact (like most) lose a significant amount and you "rebalance" and the market tumbles again. Then what? Tough **** you lose?

[techboy]

I think in a couple of years when the FED has jacked interest rates to temper inflation during the economic recovery, bonds are going to be a great buy.

Some people are still milking 30 year Treasuries they bought in the 70s that have 15%+ payouts. Can you imagine?

[techboy]

He's using hindsight and he acknowledges that most people wouldn't have made this decision at the time and most lost significantly more than that small percentage.

He's pointing out that most people didn't stay the course of buy and hold, and rebalance as they should have. They are the ones that got hammered.

Far from a cover-up, this is the point of the article. Buy and hold would have saved them, but they panicked and tried to get in and out. It cost them.

My question is this... if you did in fact (like most) lose a significant amount and you "rebalance" and the market tumbles again. Then what? Tough **** you lose?

Rebalance again. Buy low, sell high.

Market timing's worse.

[Elessar78]

SEC! SEC! SEC!

(strangely appropriate, no?)