Market timing always a bad idea
Last Tuesday the Dow Jones industrial average dropped 213.66 points with only one of the 30 components advancing. This was also the fifth consecutive down day and the longest losing streak since an eight-day period in August 2011.
In reaction to the losing streak, many bearish analysts used the financial media to chirp about the Dow and the S&P500 Index breaking down below their relative 50 day moving averages (50-day MA).
The recent string of losses is also a perfect environment for those market timers who claim investors can time the markets in order to generate better returns. That means selling a portion, or all of your equity exposure on a signal from some black box with a view to buy back in at lower prices.
Now just before investors get bullied by the “sell in May and go away” gang we now have the 50day MA breakdown gang to contend with. The strategy here is to sell on price decline under the 50-day MA and to buy on a price advance above the 50-day MA.
The 50-day MA is technically significant for traders who have a relatively short time horizon because the major stock indices tend swing above and below the 50-day MA several times in a running 52-week time window.
One flaw in trading the price swings above and below the 50-day MA is the high degree of whipsaws or false signals. For example, the S&P/TSX Composite has issued seven 50-day MA buy-and-sell signals since the October 2011 lows with only one profitable trade.
The other flaw is the tendency for market timers to focus on the broad stock indices instead of the sub-indices or stock sectors such as financial, technology, energy and the consumer sectors.
In spite of our broad S&P/TSX Composite currently trading below the 50-day MA, only five of the 10 S&P defined sectors are trading below their respective 50-day MAS. We also have the same picture in the U.S. with the broad S&P500 trading below the 50-day MA and only five of the 10 S&P defined sectors are trading below their respective 50-day MAS.
The major flaw in market timing would be for an investor to sell or reduce the equity portion of a solid portfolio based on a timing “sell” signal only to have the market continue upward without him or her on board. This is a tragic waste of opportunity in a bull market and the emotional trauma of being forced to buy in at higher prices is simply not worth the aggravation. Now there is a better way to deal with normal bull market corrections without blowing out one-half of your portfolio based on a market timing signal. An investor would employ a rebalance strategy such is to reduce exposure to the best quarterly sector performers and to direct the proceeds into the worst quarterly sector performers. The three best 2012 first quarter sector performers on the TSX were the TSX Health Care, TSX Consumer Discretionary and the TSX Financial sectors. The three worst 2012 first quarter sector performers on the TSX were the TSX Energy, TSX Diversified Metals & Mining and the TSX Global Gold sectors. Keep in mind that many components of the Metals & Mining and Global Gold sectors are replicated in the TSX Materials sector. It has been difficult not to notice the bearish stampede out of the natural gas producers, uranium miners and gold miners. The perception among investors was that if the related commodity prices in natural gas, uranium and bullion were to continue to fall, there was no point owning the related producers.
The price of natural gas has been in free-fall for months triggering a bearish stampede out of the natural gas producers. Some producers have had their prices driven down to unsustainable negative price deviations from their long term moving averages.
These oversold gassy producers will eventually ignore the current reality and anticipate the eventual return to higher gas prices. I do recall that many of today’s mid cap gold producers were trading for pennies in 2001.
Our chart is the weekly closes of the TSX listed BMO S&P/TSX Equal Weight Banks Index ETF (ZEB) plotted above the weekly closes of the TSX listed BMO Junior Gas Index ETF (ZJN).
The ZEB is an equal weight basket of Canadian banks and the ZJN is an equal weight basket of junior natural gas producers. Instead of market timing an investor would reduce exposure to the rising ZEB and increase exposure to the declining ZJN. Bill Carrigan, CIM is an independent stock-market analyst.