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Market Timing: Important Again 9-3-2009, Porter Library, Westlake, Oh. Dr. Gary J. Harloff, Ph.D. Harloff Capital Management (HCM) Registered Investment Advisory Firm, 1994 Monthly newsletter: The Intelligent Fund Investor, 1993 795 Sharon Dr., St. 226, Westlake, Oh 44145
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Market Timing: Important Again 9-3-2009, Porter Library, Westlake, Oh Dr. Gary J. Harloff, Ph.D. Harloff Capital Management (HCM) Registered Investment Advisory Firm, 1994 Monthly newsletter: The Intelligent Fund Investor, 1993 795 Sharon Dr., St. 226, Westlake, Oh 44145 Meetings by appointment 440-871-7278, www.harloffcapital.com
Disclaimers • Educational, not investment advice • not actual performance • past performance does not insure future performance • thought to be accurate and not guaranteed
Educational talk outline • Harloff background & what he does • Why market timing • Market timing overview • Business cycle and market timing • Technical Analysis indicators: Pro & Con • Example of HCM’s advanced technology • Current market conditions • Summary and conclusions
Harloff background • Specialist in tactical portfolio management: significant original investment research, 1970-2009 • regional and national contests in 1980s,1990s • authored “Dynamic Asset Allocation: Beyond Buy and Hold”, 1-1998 Stocks & Commodities (on web site) • author book : Active Investing Wealth-Management for High Net Worth Individuals, 2007, 2008 • Ph.D. AeroSpace Engineer, 27 years, 100+ papers/ reports; 2 international papers, ....rocket science • 1970 jet engine coworker in S. Florida said “nobody can model the stock market”- personal challenge
Harloff does • Tactical portfolio management, fee-based • Time markets, countries, sectors, funds, ETF’s • Alternate investment for accredited investors • Monthly timing newsletter for self managers: “The Intelligent Fund Investor”: time funds, S&P500, bond, & gold, examples • Investment speaker at AAII chapters: Louisville Ky, St. Louis, Mo, and Fl West Coast, Fl Central, and Fl SouthWest: Sept. 2009 • Post Modern Quantitative Analysis: not TA
Average investor compound return is 9.24%/yearLESS THANS&P500 compound return %/year* BEFORE COMMISSIONS & FEES 1984- 1984- 1984- 1984- 1987- 1988 1997 1998 2000 2002 2007 2008 Avg. investor,% 6.7 7.25 5.32 2.57 4.5 1.87 S&P500,% 17.1 17.90 16.29 12.22 11.8 8.35 Avg. -S&P500 -10.4 -10.65 -10.97 -9.65 -7.3 -6.48 *source: Dalbar Inc. Financial Services of Boston, Ma., Quantitative Analysis of Investor Behavior Study 1997, 1998, 2000, 2003, 2008, 2009 updates
Professional Money Managers • 5 to 10% beat S&P500 in any given year • Question- who do you want managing your portfolio?
Investing is hard because: • Markets change • change inconsistent with buy-and-hold • companies fail over time (GM stock => zero) • capital leadership shifting from US to Asia • manufacturing already exported from US • service jobs being exported from US • new industries born/die every 3 years • Who makes ongoing asset allocation changes for you?
Why market timing? • Bear markets: investor losses $ and faith in buy-and-hold strategy/advisor • When buy-and-hold performs there is less interest in market timing • Bull market asset allocation different than bear market asset allocation • Need for ongoing asset allocation • Business cycle aspect important
Market timing overview • Old as Dow theory: buy (sell) when transportation and industrials are both going up (down) • Buy/sell = timing; opposite of buy-and-hold • Big question is what to buy/sell and when • Most planners/brokers: timing is a waste of time • Most mutual funds have trading constraints • ETF’s- no limitations: will overtake mutual funds
Market timing, cont’d • Form of risk management (not insurance) • No single method or product; many approaches • Time consuming, sometimes works/doesn’t • Not taught in MBA programs at university • Not taught to CFP/CFA pass-exam designees • Planners/brokers are generalists and not portfolio managers; mostly buy-and-hold diversified portfolios for long term. No market timing. Product sales may lead to conflict of interest.
Timing is all about: • Buy low and sell high • identifying what to buy/sell when • invest in up markets and not (or short) in down markets • invest in good sectors, indexes, countries when they have profit potential and not when they don’t
Markets • Don’t have laws of motion...not predictable • Quantitative systems of HCM • Many try to build “logical systems” • Many look for patterns to repeat • Technical analysis is used by many
Timing is advanced technology • Many planners/brokers: timing is irrelevant • Investors feel the pain of buy-and-hold during bear markets. • May lose faith in buy-and-hold stay-the-course advice • Many investors wonder if advisor knows anything more than investor knows • Recent bear market losses, so timing is back in favor as an investment strategy
One approach: Technical Analysis (TA) indicators, pros & cons • Price higher/lower than 20 week ave (MA) • 21 day moving average, 30 week MA, etc. • What MA or EMA to use when? • momentum = price (t)/price (t-dt) • Relative strength index, RSI= [p(t) / P(t-dt)] /[ S&P500(t) / S&P500(t-dt)] • The Encyclopedia of Technical Market Indicators, Robert W. Colby, McGraw-Hill, 2003, 820 pg. >100 technical indicators
TA indicators: Pros & Cons, cont’d • Qualitative: people read same chart differently • Many use TA, ubiquitous, on-line graphs • Sold in many cities through infomercials • Fun: lots of indicators to discuss and review • Graphics appealing and requires judgement; beauty in the eye of the beholder • Indicators may not work for different markets, sectors, indexes, (ex. gold or bonds)
TA indicators: Pros & Cons, cont’d • Usually relative, rarely absolute: may ride down when market goes down • Empirical: don’t know when TA will stop working • Gives hope ........that individual can compete with professions with much more sophisticated analyses and computer power • Individual up against Ph.D.’s, banks, hedge funds • To win, need better tools or intuition than banks! • Doesn’t account for business cycle concepts
HCM gave up on TA as an investment system • In early 1990’s Harloff found computerized back-testing of TA indicators not profitable • Graphs different than back-testing indicators • Indicator overload: one says buy another sell • TA: may lead to false sense of capability • One index illustrative even if it lags
Vix index: 11 month delayed risk surrogate, recession started Dec. 2007
Other strategies • Buy-and-hold a diversified portfolio: usually cite MPT:1952 method (Nobel prize) • MPT all in all for planners/brokers • Some count Morningstars: based on 3 year averages=> not profitable in bear market • 60/40, 40/60 equity/bond ratio (buy-hold) • Age dependent: older- buy more bonds • Endowment practices • Business cycle concepts
Buy-hold a diversified portfolio Nobel prize method- problems • 1952 technology called “modern”: pre computer • Markowitz in 1952 developed “MPT” • MPT (buy-hold)=> not useful in bear market • Non-correlated assets supposed to lower portfolio risk, but don’t, assets highly correlated today • Statistics input into computer programs are assumed constant........ but aren’t
60/40, 40/60... ratio • Many retail advisors: 60/40 equity/bond ratio w/o regard to market conditions • May be optimum ratio if correctly forecast: (1) market return vs. risk, & (2) risk tolerance • 60/40 not optimal in bear or bull market • Market return vs. risk always changes • Ivy league endowments use 86/14, see next slide
Ivy League endowment allocation 86/14(source Barrons, 6-29-09)
Market timing & business cycle (BC) sector rotation(source: S. Stovall’s S&P’s Guide to Sector Rotation)
Does sector rotation outperform business cycle investing? Relative performance from 1948-2006(source:J.Stangl, B. Jacobsen, N. Visaltanachoti, Massey U., Dept of Commerce) • Optimal sector rotation (20/20 hindsight) timing business-cycles stages earned 2.01% alpha • Apparent out performance is quickly dissipated without hindsight and transaction fees • Alternate strategy switch to cash as business cycle enters a recession: superior returns to sector rotation • Market timing invests fully for all periods except the first period of a recession when only cash is held. • The terminal value for market timing is slightly higher than sector rotation at $1,142 and $1,094 respectively.
Does sector rotation outperform business cycle investing? Relative performance from 1948-2006 (cont’d) • Overall, market timing (0.18) also outperforms sector rotation (0.15) from a Sharpe ratio perspective. • Market timing advantage: forecast 1 business-cycle stage rather than 5 stages & lower transaction fees • Market timing: better diversification than sector rotation. Even for an investor with the ability to correctly time business cycles, a simple market-timing strategy would be optimal to sector rotation. • Conclusion: contrary to conventional market wisdom, rotating sectors over business cycles is not an optimal investment strategy and question the widespread acceptance of sector rotation.
Business Cycle Timing: source:(J.Stangl, B. Jacobsen, N. Visaltanachoti, Massey U., Dept of Commerce paper)
Harloff & Eacott business cycle study • “U.S. Business Cycle Math Quantification”, Harloff and Eacott • Need reliable real time analysis as to when recession starts, NBER often 12 months late • Analyzed 32 business cycles • Developed new equations for expansion and recession cycles
Used NBER dates and duration of 32 complete expansion and recession from 1854 to 2001 • Home-work for later BC math modeling • Free paper on web site, www.harloffcapital.com/articles.html • and • www.scribd.com/doc.../US-Business-Cycle-Math-Quantification
Harloff BC math model: system of 9 ODE’s, cycles about 5 years, preliminary
HCM math model of BC • Looking for unpaid researcher to join me in math modeling b.c. (8-16 system of stiff ODE’s). • HCM has running computer program, call me! • Need to be able to solve stiff system of ODE’s
HCM 3 new quantitative systems (not TA) • Significant resources expensed over many years by Ph.D.: HVI, trade, and vector. • Quantitative calculations and statistics to manage portfolios • Universal indexes, absolute momentum • Compute, rank, sort funds • 1) Harloff Value Index (HVI) system (>16 yrs) • 2) Vector system (> 16 years) • 3) Trade system (several years)
Current Market Conditions • The Intelligent Fund Investor monthly newsletter, 8-21-09 issue • employs Harloff Value Index (HVI) for all funds and indexes
The Intelligent Fund Investor Newsletter, employs HVI; Current Market Conditions • Performance of portfolios and timing calls • History of portfolios and trades • Timing S&P500, NDX, gold, bonds • HVI used to select portfolios • Example how to use newsletter analysis
The Intelligent Fund Investor, 8-21-09 Portfolio Performance_ ________________YTD, % Ave of three portfolios (-11.54% 2008)........ 47.18 Dynamic Frontier portf. ( -3.20% 2008)......... 26.61 No-Load Agg Gr portf. ( -0.45% 2008)......... 56.13 Rydex portfolio...............(-30.97% 2008)......... 58.81 S&P500 index.2009......(-38.49% 2008).......... 13.60 NDX100 index.2009.....(-41.89% 2008)........... 35.17
The Intelligent Fund Investor timing signals,8-21-09 Market Timing, long termgain,% S&P500: 08/21/09 1026.13 33.51 last signal(e): buy 03/20/09 768.54 NDX100: 08/21/09 1637.78 37.96 last signal(e): buy 03/20/09 1187.18 Gold, XAU: 08/21/09 147.37 -1.42 last signal(e): buy 07/24/09 149.50 US10 yr bnd yield %: 08/21/09 3.56 0.00 last yield signal(e): sell 08/21/09 3.56
The Intelligent Fund Investor absolute momentum, 8-21-09 Table 3, HVI, change, nav, 4wk % change, 13 wk % change, risk, risk adjusted, HVI/risk, 13 wk/risk, risk level (high, medium, low), and buy/sell 8-21-09 R-F obj HVI %ch nav 4wk 13w rsk rsk HVI 13w rsk b/ adj rsk rsk lvl s INDEX FUNDS 1 ProFunds INV:Banks Ultra BKPIX g 544. 0. 6.94 36.9 43.1 7.7 4.6 1.4 5.6 h b 2 ProFunds INV:UltraSector REPIX sr 464. -9. 12.86 23.8 42.6 7.9 1.8 1.1 5.4 h b 3 ProFunds INV:UltraSector FNPIX sf 411. -4. 6.83 23.5 37.1 4.7 3.9 1.7 7.9 h b 7 ProFunds INV:Ultra MidCa UMPIX i 311. -10. 22.68 12.3 41.7 2.9 -0.1 2.1 14.4 h b 8 Rydex LargeCap Value-H RYZAX i 309. -5. 64.30 15.6 28.7 3.2 2.6 1.9 8.9 h b 9 ProFunds INV:Ultra Small UAPIX i 309. -8. 11.48 12.2 45.3 2.9 -0.7 2.1 15.8 h b 10 Rydex SmallCap Value RYAZX i 306. -9. 24.51 14.6 45.7 2.1 1.6 2.8 21.4 h b 11 ProFunds INV:Basic Mater BMPIX g 293. -13. 29.20 10.9 27.7 3.3 -0.6 1.7 8.5 h b 13 Rydex Real Estate-H RYHRX i 282. -9. 19.81 14.6 27.3 4.6 1.6 1.2 6.0 h b 14 Rydex Titan 500-H RYTNX i 269. -7. 18.77 10.5 34.6 1.9 0.5 2.7 17.9 h b 15 Rydex Long Dynamic Dow 3 RYCVX i 260. -9. 14.57 9.6 32.2 2.2 -0.1 2.3 14.9 h b 16 ProFunds INV:Ultra Dow 3 UDPIX i 258. -9. 18.70 9.5 31.4 2.2 -0.1 2.3 14.5 h b 17 ProFunds INV:Ultra Bull/ ULPIX i 256. -8. 27.63 9.7 32.5 2.0 0.0 2.4 15.9 h b 18 Rydex MidCap Value-H RYAVX i 252. -11. 23.88 11.7 30.8 2.4 0.9 2.0 12.8 h b 19 ProFunds INV:Ultra Secto IDPIX g 248. -9. 22.25 10.9 26.6 2.2 0.8 2.2 12.3 h b 20 Rydex INV:Banking/242 RYKIX sf 243. -5. 45.99 15.2 19.9 3.8 2.8 1.2 5.2 h b
The Intelligent Fund Investor Monthly Newsletter: 3 Portfolios,8-21-09may differ from managed account portfolios Dynamic Frontier , Ticker % Direx Latin Am, DXZLX 34 Rydex SmCp Vlu, RYAZX 33 Rydex Titan, RYTNX 33 No-load, Aggressive, Ticker % ProFnds U Bank, BKPIX 34 ProFnds U Real Est, RYPIX 33 ProFnds U MdCp, UMPIX 33 Rydex Portfolio, Ticker % Rydex LgCp Vl, RYZAX 34 Rydex Sm Cp Vl, RYAZX 33 Rydex Real Est, RYHRX 33
Optimal timing with HCM’s “trade” system • Trade: single system that times S&P500, oil, bonds, .... All funds • Trade computes optimal timing for each fund and index • Trade system: different signals for each
Summary and conclusions • average individual under-performs S&P500 by 9.24% before commissions and fees; may need professional help beyond planner/broker • Market timing needed over full investment cycle • Asset allocation should change with market condition • Business cycle awareness important • MPT isn’t modern or useful in bear market
Summary and conclusions, cont’d • Timing is difficult and opposite of buy-and-hold • TA doesn’t add value when put to computerized back testing test. Graphics are deceptive • “Intelligent Fund Investor” monthly timer newsletter: good performance • Timing illustrated for S&P500, gold, bonds, funds • Current market conditions: new bull market March 2009. Good areas now are emerging markets, value, commodities, real estate, and banks