Hummingbird's Naval

I like to scan through certain mainstream news and financial sites on a periodic basis to get a sense of what is being written about and as a very imprecise sentiment indicator. I also scan these sites to kick my brain into gear and possibly come away with ideas for commentaries.

The title of John Waggoner’s latest piece in USA Today’s Money section caught my eye, “Investing: Market Timing is for the birds.” About half way through the column I knew I had my next commentary.

The premise of the article is that if investors watch the stock market they worry. If the market is up, they worry it will fall. If the market is down, they worry it will fall further. So, most investors are better off bird watching rather than market watching.

I’m not going to devote any time to rebutting whether or not most investors are worry warts but rather I’m going to take issue with whether you can time markets or not and also with the 2 tools he dissects in order to prove his point that markets can’t be timed.

 

Market Timing

Waggoner begins by stating that you can’t predict market tops and bottoms. This is partly correct. No one can know, in advance, what will the exact top price of a given market before a decline and the exact bottom price of a market before it turns upward.

I don’t consider “market timing” to be the ability to call the exact top or bottom of a move. I consider “market timing” to be the ability to consistently perceive a change in trend that allows you to catch or avoid 70-80% of a price move, up or down. This is because:

market tops and bottoms are processes not events and
no one has a crystal ball. But just because you can’t predict that exact top and bottom of a market doesn’t mean that you can’t, with minimal effort, step aside and miss the majority of a major correction.

Case in point, when I began publishing TWR in December 2012, I had SHORT bias in GLD, which was trading at $164, that remained unchanged through October 28, 2013, when GLD was trading at $130.

GLD peaked in early September 2011 at 183.23, declined over the next month and then traded sideways until hitting an intermediate-term peak in October 2012 at 172.62. GLD went on to have a major correction which finally bottomed in late December 2013 at 115.94, for a total peak to trough decline of 33%.

If you heeded TWR’s SHORT bias, then you missed 60% of this decline. If you heeded the NEUTRAL bias I maintained in GLD from October 28, 2013 through January 6, 2014, then you missed 88% of the decline.

Obviously, if you shorted GLD based on this bias, you made money instead of just not losing any. And I’m not cherry picking, at some point over the almost 2 years of publishing TWR, I’ve caught these types of moves in every one of the Focus Markets.

I am ALWAYS late to these types of trend changes and ALWAYS early to get out or switch a bias at the end of a move. ALWAYS. But the beauty is that market timing in the form of consistently capturing or avoiding 70-80% of a move can be accomplished. 

 

The Mind of God

Waggoner goes on to say won’t get an accurate warning from market timing professionals and then gives a long diatribe about the Elliott Wave Theorist newsletter.

Waggoner does correctly point out that EWT are perma-bears and if you say the big crash is coming week after week and month after month, eventually you will be correct.

But what was your track record during all the years leading up to the crash? That said, I have two issues with this segment of the article.

First, are newsletter writers really “market timing professionals”? Based on my own due diligence, it appears as though most newsletter writers are not professional money managers, they don’t manage real money, in real time. They manage fake money in fake portfolios.

I’m much more inclined to listen to the warnings or forecasts of guys that are at the helm of billion dollar books rather than a guy whose virtual trades tell you to buy an ETF that trades 4 shares a day. 

Second, he picked the worst representation of newsletter writers to make his point. Elliott Wave Theorists rely on Fibonacci ratios for their forecasts. This is not the DaVinci Code or Angels and Demons.

I’m certainly not Tom Hanks and I’m not running around Paris and the Vatican. Ralph Elliott wrote about how ratios were responsible for many things in the universe, how you could read the mind of god and if ratios are so important in nature then they should run financial markets as well. I didn’t make that last part up. 

The reality is that Fibonacci ratios do not have an objective influence on prices and as such do not provide a trader an edge in the markets. My own personal research bears this fact out and if anyone is aware of statistically based research which says otherwise, please email me.

In addition, most Fibonacci-based philosophies incorporate 50% as one of the re-tracement levels. This interesting for 2 reasons:

This is not a Fibonacci ratio and
Its actually the one retracement level that does have an objective influence on prices, albeit with a very wide margin of error.

So, do yourself a favor and leave Fibonacci sequences for Hollywood; take them off your charts immediately and out of your investment process entirely.

For those of you who are still not convinced and are determined to include witchcraft as part of your process, EWT issued a warning last week that the worst sell off in 50 years is upon us.

 

Moving Averages

Waggoner moves seamlessly from Fibonacci re-tracements to another well publicized, highly utilized “predictor” of market activity that has absolutely no real value to a trader, moving averages.

He notes that if you used “a basic timing method is to measure the Standard & Poor's 500-stock index weekly against its 39-week average. If the S&P 500 is below its 39-week average, you sell.

And, had you followed this technique, you would have gotten a sell signal in July 2007. Unfortunately, you would have gotten a buy signal in August 2007, a sell signal in early September 2007, and then a buy signal in mid-September that lasted until November 2007.”

Moving averages are worthless in providing a repeatable edge to traders because like our Fib ratios, moving averages provide no objective influence on price. Particularly in equities, the effect of any moving average is wholly explained by mean reversion.

There are no special moving averages, 20 vs. 50 vs. 200, not even the super sexy 39 week moving average influences prices. If you use a moving average slope to trade you are wrong. Historically, stocks tend to go down when their moving average is sloping up. Counterintuitive, I know, but the research bears this out.

It has to do with what happens when the moving average flips and what happens to trends at the end. Using the slope puts you on the wrong side of the market. In addition to not being reliable indicators of future trends, moving averages also do not provide support and resistance.

Even if all of this weren’t true and moving averages were the Holy Grail, who would use one indicator, with one duration, to determine if a market has topped or bottomed?

So, while I agree you can’t call tops and bottoms, I know for a fact that you can consistently “market time” and participate in or avoid large declines if you are paying attention to the specific elements of a given market that are both historically and statistically significant, which does not include Fib ratios or moving averages.

Do yourself a favor and spend less time watching talking heads on CNBC or reading newsletter writers that are perma-end of the world that end up being right once every 10 years and lose their asses for the nine years in between.

But If you’re still not convinced then maybe you should take Waggoner’s final advice: “If you're terrified of a stock downturn…your best bet now is a money market fund, despite the fact that the average money fund yields just 0.01%. After inflation and taxes, your returns will be smaller than a hummingbird's navel.”