Timing the Market

Courtesy of Jean-Luc Saillard.

A while back wrote a post about a method for timing the market that I read in an old article of Active Trader (Mebane Faber – April 2009). The author claimed that using a simple moving average on a monthly chart would yield better returns over time and reduce drawdowns. The strategy between 1900 and 2008 returned 10.45% a year versus 9.21% with no timing but the big difference is the 50.31% drawdown as opposed to 83.66% without timing!

Here are some illustrations of the equity curves comparison:

Keep in mind that the vertical axis is a log scale – the difference today is between $1 million for the non-timing system and $5 million with timing!

The next graphic shows the same comparison since 1972, but also adds a curve for a margin portfolio with 2x leverage (non-IRA for example)

Once again, the vertical axis is a log scale. Clearly, the Internet bubble years between 1996 and 2001 were favorable to the non-timing system, but the subsequent crash helped the timing system recover nicely – lower drawdown do help! A leverage portfolio performs much better than its 2x leverage would indicate!

With that in mind, I though that I would refresh my charts to see where we stand. So below is the latest monthly chart with a 10 period SMA as recommended by the author.

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I have circled in green the month where the system would have put us in cash. It’s not perfect as for example in mid-2004 and mid-2010, we would have been kicked out in the middle of a rally. But otherwise, the system keeps up out of big bear markets! And the last signal to get out comes at the end of last month when the August monthly bar closed below the 10 period SMA! And pretty convincingly. September did nothing to help either so this might signal the start of a correction!

So, where does that take us – let’s look at the 2008/2009 correction in relation to the previous rally:

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We retraced over 100% of the gain with a congestion zone around the 38.2% line. Now, let’s look at where we stand now:

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We have retraced to the 23.6% line so far, but broken it. The next line which proved temporary resistance (38.2%) stands at around 102 on SPY. I am not making any predictions, but this would be the most logical point of resistance. In 2010, we had a mini-corrections but the 23.6% line held:

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That has not been the case this time, so we might need take this more seriously!

In my next post I will outline a timing method used by another market analyst with a good track record! His method also indicates that we should have moved to cash a while back!