Morningstar's Rekenthaler on Modest Market Timing

John Rekenthaler of Morningstar considers the case for modest market timing and concludes that “market-timing can be one of many useful items on an investor’s ‘shelf.'” Reviewing an article by Cliff Asness, Antii Illmanen, and Thomas Maloney, he concedes that they offer a reasonable case for a modest approach to market timing, despite Rekenthaler’s own previous arguments against timing. The modest approach advocated by Asness et al. includes not only the familiar long-term metrics (such as CAPE or Shiller P/E), but also a second, shorter-term, “indicator of momentum.” Rekenthaler states: “the authors look at the past 12 months’ change in stock prices, with higher performance indicating stronger momentum and thus larger stock weighting.” He continues: “The ideal buying opportunity for this two-pronged model therefore comes when stocks have low price ratios and the market has recently rallied,” noting also the converse conditions provide strong sell signals under the approach.

Based on historical data, considering both the longer-term and shorter-term metrics produces a significantly better result than either the index approach or the long-term metrics alone. While the case for timing through the long-term only approach is undermined by data from 1950 forward, despite an apparent advantage based on earlier data, Rekenthaler notes the two-pronged approach does significally better over the full 115-year period for which data is available. Such a “market-timing portfolio doubles the gains of the buy-and-hold portfolio” over that longer period. It “added about 50 basis points to annual performance after 1950,” Rekenthaler suggests.