Why Market-Timers Go Nuts

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How do you drive a market-timer nuts? Remind them of the evidence against them.  That is, the evidence of shifting and even reversing correlations between stock and bond returns that make it improbable - if not impossible - to use market timing to make profitable investment decisions.

Market timing is a fool’s game – academic research proves that. But journalists have to write about something, and anything that appears current will likely pass muster for a busy editor’s review. Reporters continually seek out opinions on the latest ups or downs of the market. Their questions are typically in the vein of, “Why is the market doing this or that? What are advisors doing about it? Does this tell us anything about the future?”

It is not difficult to find a wide variety of answers to those questions. For those who understand a little about probability theory, it is amusing to listen to the prognostications of active managers speculating why the coin turned up heads this quarter instead of tails. They are trying to explain random events – it is no wonder they have a hard time.

This is why market timing has always been, is and always will be a losing investment strategy for the long term.

To be a successful market-timer, you must not only predict what will happen but also when it will happen. For example, almost everyone agrees that interest rates will go up, but no one can accurately say when. Even economists who are willing to go on the record have a hard time predicting rates with accuracy (see this study).

It is easy to see why rates are expected to rise – they cannot go much lower. Figure 1 shows the very long-term behavior of 10-year Treasury yields dating back to 1800. The past 30 years or so have provided great returns to bond investors, as rates fell from historic highs to historic lows. Since zero is the bottom line, we know that rates must rise (or at least not fall).

Figure 1

10 Year US Treasury Bond Yields