Is successful market timing possible?
I doubt that the age-old debate over this most basic of investment questions will ever be resolved once and for all. But one market timer has just proposed a novel way of at least trying to resolve it -- a public challenge and a monetary bet.
The adviser issuing the bet and challenge is Robert Thompson, founder of Bay Capital, a Tampa-based money management firm that strongly believes in market timing.
He was prompted to make the challenge by a comment made recently by Pat Dorsey, director of stock analysis for the Morningstar StockInvestor newsletter. Dorsey dismissed advisory firms such as Bay Capital by saying, simply, that "Market-timing is bunk."
That incensed Thompson enough to fire off a letter to Morningstar that reads, in part: "As professional market timers, we propose the following opportunity to back up your opinion." Morningstar would create a $10,000 account as of Jan. 1, 2003, just as would Bay Capital. Morningstar's account would buy and hold a Russell 2000 index fund, while Bay Capital's would trade back and forth between long and short positions in that index by switching between the Small-Cap Profunds (SLPIX: news, chart, profile) and the Short Small-Cap ProFunds (SHPIX: news, chart, profile).
At the end of 2003, whichever manager has the better performance, both in terms of raw returns as well as risk-adjusted performance, gets to keep all the money. (Though both sides would have the right for four additional years to double up on their bet.)
Thompson has yet to hear back from Morningstar. But he has created his $10,000 account anyway, and says he will be sending brokerage statements for that account to the Hulbert Financial Digest for monitoring. I will be reporting on the account's progress at various intervals throughout 2003.
In the meantime, what light does the Hulbert Financial Digest's research shed on this perennial debate over market timing? In a nutshell, the HFD has found that while market timing is difficult, it can be done. So both sides in this debate can find some support for their position.
This middle-of-the-road posture is well illustrated by the findings of a recent academic study of the Hulbert Financial Digest database by Alok Kumar and Vicente Pons, doctoral students in economics and finance at Cornell and Yale universities, respectively. Their study as yet is unpublished, and is instead circulating in academic circles as a working paper: "Behavior and Performance of Investment Newsletter Analysts."
On the one hand, Kumar and Pons found that the average investment newsletter does not have market-timing ability.
On the other hand, they found that the percentage of newsletters whose market timing has beaten a buy and hold on a risk-adjusted basis, while below 50 percent, nevertheless is greater than can be expected by pure chance. This was true regardless of how the researchers adjusted for risk (and they used a half dozen different formulae).
What this suggests is that, while Thompson has his work cut out for him, he has a fighting chance of winning his wager.
Stay tuned.
In the meantime, best wishes for a happy and prosperous New Year.
For more information or to subscribe to the Hulbert Financial Digest, click here.
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