There is a way to sacrifice a bit of return, but in exchange have a chance of avoiding a major downturn. And this approach is much better than simply guessing at timing the market.
What is exciting is that this is free to run and, to be honest, has a decent shot at helping you to outperform the market over the next 10 years. Frugal Investors follow the data and the data suggests this has a good probability of working!
Health warning: it involves a much greater time commitment than simply buying and holding balanced index trackers that follow the market. Unless you have been investing for a couple of years and you can afford to follow this on a daily/weekly basis, you may want to consider simply being invested in the market.
Current Environment
In 2020 the idea that investors are going to receive 10-12% average annual returns, over the course of the next ten years, is incredibly myopic. Especially given that in August 2019 a poll suggested 74% of economists expect a recession by the end of 2021.
If you don’t believe that poll, then just look at what governments are saying about the predicted rate of growth in your pensions. The Canadian government and UK government both forecast real rates of return out to 2035 of around 3-5% – less than half of what we’re currently getting.
I believe that there’s a good chance the forecasters are right. The yield curve has inverted and un-inverted, and as it happens the fact that it has corrected itself is a strong sign a recession is coming. Corporate debt is colossal; there are major businesses whose debt puts them one notch above junk-grade bonds. Common market valuations like PE, CAPE and PB are historically high. Mergers and acquisitions activity is at all-time highs. The list goes on: this is a market with a shelf-life, and however much we hope it will go on for another ten years, it is unlikely to. Ironically that hope is another sign that this market is doomed, i.e. it has gone beyond all rationality and reason.
This doesn’t mean I am out of stocks (which is not a good plan). It means I have a finger on the pulse and a good cushion of bonds, gold and fixed income with the other 50% of my assets that isn’t invested. My plan is to avoid the next bear market as best as possible and to preserve wealth for when assets are significantly under-valued.
The Market Timing Model
For a full description of what the Market Timing Model is and how it works, please read through A Market Timing method that works: Sell when the S&P 500 or FTSE All Share Cross Their 200 Day Moving Average.
As you will have learned from the article above there is a method for timing the market that can give you a chance at out-performing the indexes.
Over the last 10 years this method has actually only given you an extra 0.18% return over the market. In essence, the market has been rising about 18% a year since the market lows in 2009, so timing the market hasn’t really worked as it has historically during this bull market.
That being said here is a table summarising the S&P 500 and FTSE All-Share performance against the 200 day moving average Market Timing method during the worst annual falls on record:
| Bear Market Date | S&P 500 Performance | FTSE All Share Performance | Market Timing Model Performance |
| 1907 Banker’s Panic | -30% | -15% | -0.1% |
| 1930 Great Depression | -25% | -19% | +2.5% |
| 1931 Great Depression | -44% | -23% | +1.41% |
| 1937 Market Crash | -35% | -20% | -7.7% |
| 1973 Arab Oil Embargo (1) | -15% | -31% | -15.6% |
| 1974 Arab Oil Embargo (2) | -27% | -55% | +8.2% |
| 1987 Black Monday | -26% | -22% | 0% |
| 2000-2003 Dot Com Bust | -42% | -48% | -1.5% |
| 2008-2009 Great Financial Crisis | -49% | -33% | -13% |
| AVERAGE | -33% | -42% | -2.9% |
As
you can see the out-performance is phenomenal and it is superior in many ways
to using puts/calls to time the market, because for the vast majority of the
time you’re simply invested until things start to go down meaningfully.
How has the MTM done this year? It tripped 4 times this year and it would have had you out of stocks from January 1st through to March 15th 2019. That would have cost you nothing if you had followed the model the previous year and sold on 4th October 2018 and then held cash until 15th March 2019. You would have lost income but nothing in terms of capital because the FTSE All Share and also the S&P 500 were lower when you re-bought in March.
Why it may be worth following the Market Timing Model
At Frugal Investors we will periodically update the Market Timing Model when a significant event happens.
The MTM is a cheap insurance policy. When the ‘big one’ comes you will not experience much of the fall. We are at a moment in history when this approach has a good chance of working over the next ten years (2020-2030), and I will put my flag in the sand to explain why:
- When the market is going up the Market Timing Model barely outperforms the market with a 0.18% improvement on the S&P 500 or FTSE All Share
- When a bear market occurs the Market Timing Model out-performs the market by 30% against the S&P 500 and 39% against the FTSE All-Share
- The S&P 500 index is up 404% since March 2009 as I write this on 25th December 2019
- Credit markets are warped and expectations are high that there will be a blow-up in the bond market before long, with virtually no difference between BBB- and BB- debt
- The Federal Reserve continues to mess with monetary policy and this benefits billionaires and rich people, not your average person (including recent interventions in the Repo market)
- Experts anticipate a recession soon, it is just a question of when
- Populist governments with poor economic and fiscal policies reign – for instance, the US corporate tax cut which is universally opposed by economists
I believe that there will be an economic slowdown and recession by 2021. I also believe that timing the market and simply selling now in order to ‘wait it out’ is not the best course of action. Equities could easily appreciate another 15%, 20%, or even 40% from today’s levels.
So what can you do?
One way to play this is to – paradoxically – stay fairly well invested and to follow the Market Timing Model. When stocks drop below their 200 Day Moving Average you would sell your positions. When stocks rise above their 200 Day Moving Average you would re-buy your positions. If you read below there is a link to an excel tracker that we have designed for following this system.
I anticipate that my Home Base Portfolio – let’s say it is worth £657,000 today – may drop 4.59% before the ‘Sell’ is triggered (as of 19th December, today). That means I would lose £30,156 from today’s value if that happened tomorrow. I would then sell my positions.
However let’s view that in context. The portfolio has returned 19.69% this year. That means I am up £108,081 year-to-date and I only have to sacrifice £30,156 of that gain before I sell everything and return to cash. I would therefore still be up by a healthy £77,925 (15.1%).
That’s a pretty darn good insurance policy. If you had taken this advice at the start of the year you wouldn’t have sat on cash and missed out on 19.69% gains. At the same time, because you’re cautious and believe a stock market crash could happen within two years, you’ve got a clear and concise exit strategy.
I think there’s a 65-70% chance that this approach will make you money – potentially a lot of money – within the next 2 years. Let’s say by 2nd January 2022. That’s my New Years’ prediction!
How to Follow the Market Timing Model
At Frugal Investors we’ve created a free excel sheet that you can access here with a macro for tracking what the 200 day moving average is currently. Read our guide on the MTM thoroughly. There are also websites here and here for tracking the S&P 500 and FTSE All Share 200 day moving averages if you want to bookmark them on your phone and check daily.
This is definitely an approach for more experienced investors. If this sounds like rocket science and you don’t fully understand it, consider sticking with a basic Buy and Hold approach (Section 1). Swot up by reading other articles and improving your investing knowledge, to move onto more advanced concepts!
For those looking to time the market, don’t bother doing it by guessing at what the news says, or waiting for stocks to sell off sharply before dunking your positions.
Use a system with a bit of logic and structure. After all the Market Timing Model has back-tested data that suggests it worked from 1901-2012 (see Meb Faber’s research here) and helped you avoid the worst of the 2000 Dot Com bust and 2008 Global Financial Crisis.
The Frugalist Investor has chosen to maintain a 50% weighting in stocks and shares, with a view to using the Market Timing model to avoid any serious downside when stocks drift below their 200 day moving average. I believe that the next major sell-off will be driven by institutions and big banks, and when they start to sell, it really will be time to exit the market. Buy-and-hold investors who hold on for a few years will likely get crushed when the ‘Everything Bubble’ pops like it did in 2000-2003.
When the the time comes (as it inevitably will), I’ll wait for the averages to recover back to their 200 day moving average, and move 75-85% of my net worth back into stocks and shares with a particular focus on dividend and income producing assets.
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