Stock Market Timing?

“Nobody can consistently time the stock market’s ups and downs.”

. . . An old stock market “saw”

We have heard the statement, “Nobody can consistently time the stock market’s ups and downs;” and, for the most part we agree with that. However, if one listens to the message of the market, one can certainly decide if one should be “playing hard,” or not playing so hard. This view has to do with our often repeated statement about managing risk. As Benjamin Graham wrote in the book The Intelligent Investor, “The essence of portfolio management is the management of RISKS, not the management of RETURNS.” Graham closed that thought by noting, “All good portfolio management begins and ends with this premise.” We will note that our long, intermediate, and short-term models have done a better job than most of smoothing out many of the “wiggles” in the various markets. Accordingly, we were quite impressed with Leon Tuey’s latest missive, where he wrote:

There is a common belief that timing is not important and that no one can time the market. I beg to differ. Those who hold such beliefs are ignorant of the market’s logic. Also, it may well be just propaganda by the fund industry for if investors can identify a bull market top and pull their money out, what would the funds do for a living?

If investors understand the market’s logic, they can divine the future direction of the market (long-term, or shorter term). It is not rocket science. Understanding the market’s long-term direction is of primary importance. If investors had bought the following blue-chip stocks at the top in 2007 - Berkshire Hathaway, 3M, Microsoft, Royal Bank of Canada, United Technologies and hundreds ofothers, they would have lost 50% or more at the end of the bear market in March 2009 and they didn’t get even until early 2013.

To understand how a bull market begins and how it ends demands a deep understanding of the economic cause/effect relationships that drive the markets. The following must be clearly understood and appreciated.

The U.S. Federal Reserve System was created in 1913 to perform all roles monetary. It’s an independent body. One of its key statutory mandates is “To maintain orderly economic growth and price stability” (unlike the European model, which is primarily concerned with price stability). The most powerful tools at the Fed’s disposal to effect monetary policy changes are the basic monetary policy variables, bank reserve requirements, margin requirements, and the discount rate. Changes in the Bank Reserve Requirement and the Margin Requirement are infrequent; the discount rate changes the most frequently. When the Fed raises/lowers the Bank Reserve Requirement, however, investors should pay close attention as when it happens, it signals monetary tightening/easing. The single most bullish indicator for the stock market is when the Fed lowers the Bank Reserve Requirement; it’s a clear signal of monetary easing. To encourage investments, or to dampen speculation, the Fed will lower or raise the Margin Requirement. The Discount Rate is the only policy variable that changes frequently. Monetary tightening is when the Fed raises the Discount Rate many times in succession; drains liquidity from the system (contraction in the year-over-year rate of growth in the Adjusted Monetary Base, MZM, and M2. Data are available in U.S. Financial Data, reported every Thursday evening by the Federal Reserve Bank of St. Louis); and inversion of the Classic Yield Curve (13-week T-Bill yield vs. 30-year T-Bond yield).

The Fed’s mandate must be clearly understood and appreciated. Failure to do so will leave investors in a state of perpetual confusion and at the mercy of the “noise.”

To divine the market’s long-term trend, I monitor six factors to help me detect how a bull market begins and how it ends. These are the monetary (the most important and the real drivers of the market’s long-term trend), economic, valuation, sentiment, supply/demand, and momentum/internal/technical. The valuation and supply/demand factors are imprecise in terms of timing. Nevertheless, they must be closely monitored. The momentum/internal/technical factors don’t drive the market; they tell investors about the health of the market.