Market Timing - The Better Way to Invest
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Most of us entrust our savings to financial organizations in the belief that this will provide us with better investment results than we could have achieved ourselves. These companies charge fees for taking our money and investing it for us, but they almost always fail to keep their implied promise to supply better returns.
A typical example of investors' futile expectations for better returns from professional stock pickers is evidenced by the poor performance of the CREF Stock Variable Annuity Account, one of the larger stock funds in the country. TIAA–CREF is a financial services organization which serves 3.7 million active and retired employees. One would expect their fund managers to manage the CREF Stock fund to provide better returns for participants than what they could have made themselves by simply investing in an index fund that tracks the stock market.
But this is not the case.
From January 2, 1992 (the date from which data for CREF Stock is available) to July 6, 2012 this $101.49 billion CREF Stock Variable Annuity Account had under-performed the Vanguard 500 Index Fund (VFINX) by 11.27%. Those who started to save for retirement 20 years ago and made hypothetical investments into this stock account of $10,000 on the first day of every year since 1992, would by July 6, 2012 have had $25,433 less than had they placed the same money with the index fund VFINX. There was not a single year from 1992 to 2012 when the sum of the terminal values for recurring annual investments placed into the CREF Stock account exceeded the sum of the terminal values for the same amounts when put into the index fund VFINX. (See table 1 below.)
The huge size of this fund – which comprises more than a fifth of the combined assets under management by TIAA-CREF – indicates that despite the ongoing poor performance, participants are still putting their hard earned money into the hands of sub-par managers who were not even able to match the returns of an index fund tracking the S&P 500.
So why do so many of us continue to entrust our money to financial service organizations when they are performing so poorly and frequently lose money for their investors?
"Its not a rational decision" according to Nobel prize winner Daniel Kahneman, Professor of Psychology Emeritus at Princeton University, who has studied the irrational behavior of investors. "He thinks the explanation is partly that we're over-optimistic about the skills of professional investors, and partly that we're too intimidated by the process of professional investing to figure out it doesn't work, and too worried by the prospect that, if we invest our money ourselves and we don't do well, we will have no one else to blame," an article in The Spectator concluded.
"So the correct conclusion is that professional investors are not insincere. They are deluded. 'Professional investors actually believe that they are very good value for money.' But they are, almost every one of them, wrong about that. [It makes no sense] to believe we will do better by entrusting our money to them. But believe it we do — and our conviction is amazingly resilient in the face of overwhelming evidence that it is false."
There is a better way to invest.
My MAC system, a model for automatic asset allocation (described in Beyond the Ultimate Death Cross), is based on cross-overs of moving averages of the S&P 500. This model would have provided, with less risk, about twice the return of a buy-and-hold investment in the Vanguard 500 Index Fund, and 2.30 times more than the CREF Stock Variable Annuity Account from January 2, 1992 to July 6, 2012.
Believable market timing models should have the following attributes:
- they must be simple, rational and rule based,
- have sufficient sample size with adequate supporting data,
- and they must be testable.
See here for a more complete discussion of this.
The MAC system complies with these requirements, unlike the models Best Stock Market Indicator (data only available for three years), and Major Sell Signal Triggered (not testable), both of which have appeared at dshort.
The key to this successful model was finding moving averages whose cross-overs have the highest probabilities of successfully signaling market gains or losses. I found these moving averages using likelihood ratios. The most profitable buy signal occurs when the 34-day exponential moving average (EMA) of the S&P 500 becomes greater than 1.001 times the 200-day EMA. The best sell signal was when the 40-day simple moving average (MA) of the S&P 500 crosses below the 200-day MA.
Below is a table listing how many buy signals from MAC (since 1966) were successfully (or unsuccessfully) forecasting that the S&P would be higher during one week following a particular investment period in the stock market, together with the probabilities of the market being higher as calculated from likelihood ratios.
The highest probability of the market being higher was found to be for an investment period of six to seven months after a buy signal. The last MAC buy signal occurred on January 3, 2012. One could have then confidently expected a higher market because of the high 92.6% probability for this to happen seven months later. This was indeed the case, as the market has gained about 8.5% from the buy signal date to July 27.
Georg Vrba is a professional engineer who has been a consulting engineer for many years. In his opinion, mathematical models provide better guidance to market direction than financial "experts." He has developed financial models for the stock market, the bond market and the yield curve, all published in Advisor Perspectives. The models are updated weekly. If you are interested to receive theses updates at no cost send email request to firstname.lastname@example.org.