Why Market Timing Works

I spent several years at Putnam Investments, and during that time, several institutional maxims about investing were repeated over and over, to the point that they just seemed true ... period. And since they were always buttressed with impressive statistics, they did, indeed, seem true.

One of my favorites was, "It's Time, Not Timing." This was to caution investors who might be tempted to cash out during bearish periods and then invest again when the bulls reasserted themselves.

The support for this rule often took the form of statistics illustrating how missing just a few great market days every year would leave your returns flatter than an Interstate possum. A recent study by the Schwab Center, for instance, analyzed returns for the decade from 1997 to 2006, pointing out that during that period the S&P 500 gained an annualized 8.4%. But if you had been out of the market for the market's best 40 days, your returns would have slipped to a loss of 6.4%.

Moral: Don't Try To Time the Market!

Cabot's response: Hogwash!

Timing Not Time

The Cabot Market Letter has been timing the market for over 37 years, and it is darned good at it. Even the Hulbert Financial Digest has noticed, giving the Letter an attaboy for its success in getting out of bear markets and back into bull runs.

There are reasons for the divergence in the opinions of Cabot and the market commentators, and they don't require that one or the other has to be wrong. It's a good illustration of the power of the individual to grab victory from the jaws of defeat. Here's how it works.

The anti-timing crowd, let's call them Team Patience, gives you only two options: either be 100% invested or 100% out. So let's suppose that you had taken your money out of your S&P 500 Index fund near the end of 2002, fleeing the field just as the Index was completing an exhausting nose-dive from its Tech Bubble high of 1553 in March 2000 to 769 on October 10, 2002. In that case, you would indeed have missed the Index's 7.5% gain during the week of March 21, 2003. And you can find lots of similar cases; just get a chart of the S&P 500 Index and look for the biggest-gaining weeks. Similarly, your crude attempt to dodge the market's bullet might have had you on the sidelines for the Index's exhilarating 1.7% jump on elevated volume just last month on December 21.

But growth investors don't invest in markets or indexes, they invest in individual stocks, which means that they don't just have an on/off switch, they have some real control. The Cabot Market Letter, whose Model Portfolio is considered fully invested when it contains 12 stocks, can dial its market exposure up or down based on the state of its market timing indicators, the Cabot Tides, the Cabot Trend Lines and the Two-Second Indicator. The Market Letter has spent the past couple of months with at least 50% of its capital in cash, and recently reached 60%.

A growth investor's cash position isn't a top-down decision, so the Market Letter's editor doesn't look at the markets and decide on a cash percentage. Rather, the editor uses the market-timing indicators as a guide to the market's central tendency, either bullish or bearish, and then evaluates each stock's chart with that tendency in mind. What might be accepted as a significant correction during a bull market could be taken as a warning signal during a bear phase.

There are hundreds of rules about investing in the stock market. Unfortunately, some of them don't agree with one another and almost all of them have exceptions and conditions. Cabot's market timing techniques are purposely simple. They're not a magic formula, but they signal you when it's time to get out of a down market and let you know when it's time to get back in. They're a large part of the reason Cabot growth letters consistently beat the broad market and occasionally beat the heck out of it.


Follow the Rules During a Bear Market

If you're an investor, you're worried. That's what you get paid for. George Gerschwin's classic song "I Got Plenty of Nothin'" reminds us that "Folks with plenty of plenty, all got a lock on the door," and it's true. If you have money at risk in the stock market (and never forget that money in the stock market is always at risk), you're worried about losses, or losing your profits, or missing the next big thing. People who don't care about winning don't play (and bank savings accounts are full of them). If you're in the market, you care, no matter how much you try to keep your risk down.

The real trick is to keep yourself from getting too giddy when stocks have handed you a nice profit or too depressed when the market throws your favorite stocks into the toilet.

It's a lot like the relationship some people have with their bathroom scale. If they get up and the scale tells them they're down a few pounds, then the sun is shining and all's right with the world. But if their weight is up a couple of pounds, they can hardly face themselves in the mirror. It's tough to put a simple machine in charge of your self esteem.

But it's equally tough to let the stock market tell you how to feel, and living through a full-grown bear market like the one we're having now will put even the most seasoned investor to the test.

There is no secret to maintaining your emotional equilibrium when the bear has ripped your favorite stock(s) to shreds. You just have to be sure that you get as much capital as you can out of harm's way and safely into your piggy bank (i.e. brokerage or money market account) so that you can start investing again when the investing climate changes.

The reason our system is called capitalism is that you have to have capital to be a player. So don't let an emotional reaction to a tanking stock keep you from selling and protecting the capital you have left. Know your sell disciplines, follow them and keep doing your homework by building your watch list of interesting stocks for the next bull run.


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One stock that has been interesting me lately is Hologic (HOLX), a developer and manufacturer of medical imaging systems that's been a big winner in the past and has been resisting the downward tide of the current bear-fest.

Hologic has a broad product line, focused on the healthcare needs of women, but the lead product is the Selenia full-field digital mammography system. This system offers a significant improvement in diagnostic results compared with earlier analog mammography equipment, and there are still thousands of old-style machines out there that need to be replaced.

The buoyancy of HOLX just put it back in the Cabot Top Ten Report for the fifth time. Interestingly, the first four appearances came in 2005 and early 2006 when the stock was working on a rally that took it from 4 in February 2003 to 56 in March 2006.

After that incredible run, HOLX traded sideways for almost 18 months, running into resistance at 60 in early 2007, then falling below 50 during the global July/August subprime slump. The stock recovered quickly from that low and the breakout came in September, when it smashed through its old resistance level on huge volume and roared to 69 before correcting for a couple of months. The latest run took the stock to 73 just as the bear was beginning to take hold earlier this month. HOLX has fallen with the market, but not as much as the market, indicating that investors still find value there.

I regard multiple appearances in Top Ten as a strong indicator of a stock's continuing market leadership, and Hologic's re-appearance on January 14 is a great sign.

If you want to keep up with the stocks that are leading the market - both during this trying slump and when the bulls take charge again - you should consider a risk free trial subscription. This link will get you started.


Paul Goodwin
For Cabot Wealth Advisory

Editors Note: Paul Goodwin is the editor of Cabot China & Emerging Markets Report. Hulbert Financial Digest recently listed Cabot China & Emerging Markets the Top Investment Newsletters of 2007 with 74.1% return for the year. Peter Brimelow of MarketWatch several days later did the same... naming Cabot China & Emerging Markets Report his 2007 Investment Letter of the Year.

Emerging markets have outperformed the markets of the developed world over the past few years, and China is the clear leader in economic growth. But it's not the only player. The Cabot China & Emerging Markets Report focuses on the BRIC countries (Brazil, Russia, India and China) and seeks out the stocks with the best stories, the soundest fundamentals and the hottest charts. If you'd like a dependable guide to investing in these intriguing markets, you should consider a no-risk subscription. Click below to get started.



Paul Goodwin can be found on Google Plus.

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