by Aaron Task

With major averages flat or slightly negative for the past 10 years, many investors have given up on the “buy and hold” strategy that became a mantra in the 1990s. That, of course, has prompted some contrarians to declare that now is the best time to be a buy and hold investor.

In this case, the conventional wisdom is right, says Lakshman Achuthan, managing director of the Economic Cycle Research Institute (ECRI).

“I’m not saying ‘buy and hold’ is a bad thing, unless you’re having more frequent recessions,” he says. And that is precisely what ECRI expects in the coming decade because of two big patterns that Achuthan says are irreversible:

One, sucessive recoveries from post WWII recessions have become weaker and weaker “on every count,” including growth, sales, employment and production.

Two, there’s more volatility in the economy, with the big swoon in late 2008-early 2009 and surge in more recent months being a glaring example.

Achuthan predicts we have entered a period of “more ‘boom and bust’-type cycles,” similar to what occurred in the 1970s. “The Great Moderation is history,” he says, referring to the period starting in the mid-1990s when many economists (and policymakers like Ben Bernanke) believed the business cycle had been smoothed out, if not eradicated.

“You don’t have to be a mad scientist,” he says; just “back off your risk in the stock market and buy bonds” if a recession appears imminent. “And if we see a recovery take more exposure and get out of bonds because the recovery is going to give you a little inflation.”

If recessions are more likely – and more intense in scope – then investors will demand higher risk premiums for owning equities, Achuthan explains in the accompanying clip.

Of course, the trick is predicting when those recessions and recoveries have begun — or are about to begin — something ECRI believes it has mastered. As noted here, the ECRI does have a good track record when it comes to predicting economic cycles. They correctly predicted last year’s strong recovery after having correctly called the 2001 and 1990 recessions. However, ECRI waited until March 2008 to officially diagnose the last recession that they now agree began in December 2007.

“I’m not suggesting we’ll get it right all the time but we’ll do a lot better than ‘buy and hold,’” Achuthan says.

Market-timing strategies score big with tense investors

By Sam Mamudi, MarketWatch

NEW YORK (MarketWatch) — Volatile stock markets have left investor confidence in tatters. Now some say it’s time to accept the turmoil and adopt more dynamic trading strategies.

Proponents of so-called trend investing — buying and selling stocks depending on technical analysis of the market’s direction — say the tactic not only enables investors to navigate unstable markets, but also prevents big losses when prices fall.

The proactive stance is winning converts at a time when concern about the strength of the U.S. economic recovery and the future of consumer spending is running high. See related story.

Yet this technique is controversial, as it counters conventional wisdom that time in the market, not market-timing, offers individual investors their best chance for success.

To trend followers, the notion of buy-and-hold investing — picking stocks based on fundamentals and keeping the investments for months or years — has no place in today’s market and in fact is a recipe for defeat.

“You have to understand the game you’re playing — you’re playing with sharks,” said Kenny Landgraf, president of Austin, Texas-based, Kenjol Capital Management. “You may believe in buy-and-hold, but there are large players out there that don’t.”

By Jonathan Ratner, FinancialPost

UBS AG is warning that a further weakening of the global economy, if not a recession, appears to be inevitable.

Top-rated portfolios perform poorly but still attract new money

By Sam Mamudi, MarketWatch

NEW YORK (MarketWatch) — Tim Courtney decided he’d had enough. In meeting after meeting earlier this year, he and his colleagues at Burns Advisory Group had recommended mutual funds to prospective clients, only to be hit with the same response almost every time: Why are you telling me to invest in a three-star rated fund?

That sums up the way many investors allocate money to funds — look at products that have four- or five-star ratings from investment researcher Morningstar Inc., take that as a seal of quality, and hope for the best. Such decisions are perhaps even more common in volatile markets, when anxious investors view top-ranked funds as somehow better-equipped to handle adversity.

Five-star funds in particular seem to have their own allure. Even in 2008’s brutal market, when the other star-rated funds saw net outflows ranging from $111 billion for three-star funds to $14 billion for four-star funds, five-star funds enjoyed $67.5 billion in net inflows.

The trouble is that investors seem to forget that star ratings are backward-looking, based on a fund’s past performance, and studies have shown the ratings have no predictive value. Read about other studies that have examined the predictive value of past performance.

“Having to get over that hurdle [of explaining that star-ratings shouldn't influence choices], every time we recommended a fund that wasn’t five-star, is something we have to do time and time again,” said Courtney, chief investment officer of Burns Advisory, which manages about $300 million and advises about $150 million of 401(k) assets.

So Courtney and his colleagues went back to Dec. 31, 1999 and studied the subsequent 10-year performance of five-star rated funds. What he found might convince investors to kick their star-rating habit.

Of the 248 stock funds with five-star ratings at the start of the period, just four still kept that rank after 10 years. And the 218 domestic stock funds with the rating typically lagged their category averages over the period — not just the benchmarks, but other mutual funds. The exceptions were 30 foreign large-cap funds, which had a 10-year annualized return of 1.44% compared to their category average of 1.32%.

In other words, it’s not just that five-star funds don’t, on average, continue to lead their peers — they actually do worse in subsequent years.

The worst performers were small-cap growth funds. The category’s 29 five-star funds in 1999 lost an average of 3.6% annualized over the next decade. The category overall was up 0.6% in the period.

Don Phillips, managing director at Morningstar, took exception to Courtney’s findings. He said that Morningstar changed its star-rating methodology in 2002 in response to problems that became apparent as the tech bubble burst. The biggest change was using 48 categories, rather than four, to compare funds to those using similar strategies.

A study of returns after the changes were made would find different results, according to Phillips, who noted that one study found that from 2002 to 2005 better-ranked funds outperformed funds with a lower rating.

“The fact that Morningstar changed their methodology [subsequently] would have not changed the outcome of those funds that were five-star rated on Dec. 31, 1999,” countered Courtney. “Although you could certainly say that if the old methodology were still in place, more than four funds may have retained their five-star ratings.”

He added: “Regardless what the method is, the star rating in our opinion should be used by investors with the knowledge that the rating should serve as only one piece of the research process.”

Courtney’s findings will have to go a long way before investors lose their starry eyes. Four- and five-star rated funds captured about 72% of the roughly $2 trillion of net inflows into all funds with star ratings over the decade through Dec. 31, 2009, according to Morningstar. Thirty percent went into three-star funds, while less than 1% went to two-star funds. (The numbers add up to more than 100% because of net outflows from one-star funds.)

There are valid reasons for inflows numbers, such as the fact that some extremely good funds are four- and five-star rated. But the figures also suggest a strong element of performance-chasing — returns that by definition are in the past and may not be repeated.

Rather than performance, Courtney said he looks for relatively low costs and low turnover in a fund, along with investment strategies he understands and which the manager doesn’t frequently change. In addition, he also prefers diversified, rather than concentrated, portfolios.

Morningstar’s Phillips commented that critics of star ratings overlook the fact that better-ranked funds are also typically the cheapest funds with the lowest turnover. He noted that on average, the better-rated funds also hold more of their manager’s personal investments.

“These are the very attributes associated with what people say they’re looking for in a fund,” he said.

Phillips acknowledged the ratings are imperfect as the sole determining factor, but said that he believes they are as good a short cut as people have when it comes to picking funds.

Courtney, for his part, takes issue with the myopic focus some investors place on the rankings. “Investors use the star ratings to the exclusion of other data,” he said. “It’s very frustrating.”

Sam Mamudi is a reporter for MarketWatch, based in New York.

By Sam Mamudi, MarketWatch

NEW YORK (MarketWatch) — Ask most financial professionals and they’ll tell you the same thing: [Most retail] investors flee the stock market and then jump back in, but too late for their own good.

The evidence of the past year seems to support that view, as new money coming to stock mutual funds has been negligible even as returns have been among the best on record. An influx into stocks in the coming months would suggest investors once again waited too long.

But something else may also be at work. While the Standard & Poor’s 500-stock index (SPX 1,144, +3.42, +0.30%) is up almost 69% in the past 12 months, the losses caused by the market crash were the worst in at least two generations. And despite the new bull market, many investors — indeed, many mutual funds — are still below their pre-crash peak.

“There’s still some sensitivity to how much was lost [in the crash] — investors are still opening their 401(k) statements and seeing losses,” said Todd Rosenbluth, mutual fund analyst at Standard & Poor’s.

The question is whether the losses were so big that they scared investors away from stocks not just for the next few months, but for years to come. In other words, perhaps the usual pattern of coming late to the party has changed.

“I don’t know if we’re seeing the demise of actively-managed mutual funds — if we are seeing a big change — but a lot of people seem to have decided to stay away from stock funds,” said Tom Roseen, senior analyst at research firm Lipper Inc.

Figures from Lipper back this view. From March 1, 2009 through Jan. 31, stock mutual funds saw net inflows of $21.22 billion — trivial for a sector that has about $4 trillion in assets. In the same period, bond funds saw net inflows of $328 billion.

So far, so gloomy. But those numbers don’t tell the whole tale. While stock mutual funds saw poor inflows in the first 11 months of the bull market, some categories fared much better than others.

International stock funds saw $46.5 billion in net inflows — fairly substantial flows for a category that had about $760 billion in total assets at the end of January, according to Lipper. Gold and natural resources funds, meanwhile, only saw net outflows in one month during the period — July — and the $40 billion category ended the 11 months with net inflows of $4.2 billion.

The bulk of the outflow has been from U.S. stock funds, which means that investors have been withdrawing money out of the market even as prices have risen sharply. While surprising, it may suggest that investors are being careful in how they allocate cash.

As Roseen noted, while large-cap U.S. stocks are often seen as a safe harbor in a recession, the recent crisis quashed that perception. A weak dollar, higher prices for gold and natural resources and bargain-hunting may have led people into alternatives such as developed and emerging international markets.

“After the routing the international market took in 2008, I think many investors saw some unique opportunities to buy securities at deeply discounted prices. For others, it might have been simply performance chasing — after all Latin American Funds were up 113% in 2009 and emerging markets funds climbed 76%,” said Roseen.

The overall flow numbers also fit a pattern. This is the fourth bull market since 1987, according to Standard & Poor’s Equity Research. Each time, net inflows into stock funds have been slow to get going before jumping in the second year.

In the first 12 months of 1987’s bull market, for example, stock funds saw $16 billion in net outflows, but that was followed by a cascade of more than $4 billion in new money over the following year. A similar surge in 1990’s bull market: Net inflows were roughly $26 billion in the first year and more than $70 billion over the next year. And the first year of the bull market that began in late 2002 saw about $90 billion in net stock fund inflows, jumping to $190 billion in the second year.

By William J. O’Neil, Investor’s Business Daily

To be a successful investor, you can’t just buy a good stock. You have to buy the very best stocks at the very best time.

And it’s not enough for you to simply study the stock itself, you also need to analyze the market conditions in which it is trading.

Five decades of historical studies on past market cycles show that three out of four stocks decline when the general market averages correct. That’s why market direction is one of the several critical factors in making money in stocks. How do you tell which way the market is headed?

You really don’t need a crystal ball. The key is learning to decipher the day-to-day market action—in other words, what the market’s doing right now. Successful investing isn’t about following pundits’ predictions or analysts’ estimates or going by how you feel. It is about studying the market itself.

There are a few key market indicators to look for that provide a trustworthy lens into how the market is behaving overall. In this article, we’ll focus on the main indicators—the Nasdaq composite, S&P 500 and Dow Jones industrials. We’ll illustrate how to use their daily price and volume activity to interpret today’s market climate.

The Market Is as the Market Does.  To be highly accurate in any pursuit, you have to carefully observe and analyze the object at hand. The stock market is no different. The idea may seem simple enough, but even with their hard-earned money on the line, you’d be surprised at how often people argue with the facts that are right in front of them.

Many investors are sometimes misled by the shouting of opinions and prognostications. Listening to opinions about the market is one of the riskiest things you can do as an individual investor. You want facts, not personal opinions. If there’s one lesson most learned from the 2000 three-year bear market, it’s that arguing with the facts and simply hoping for the best is the easiest way to lose your shirt.

Let’s start by dissecting market activity and talk about what it’s trying to tell you.

The stock market is governed by the same forces as individual stocks: supply and demand. Throughout history, the best way to determine the market’s health and direction has been to view the daily price and volume action of the three major indexes: the Dow, the S&P 500 and the Nasdaq. Volume bursts in these key indexes show where mutual funds and other institutional investors, the biggest driver of stock prices, are moving.

In an up-trending market, you normally want to see prices and trading volume rise somewhat in tandem. This shows a market under accumulation, with more positive volume than selling volume: a good sign. On down days, in the majority of cases, you want to see volume lessen. This shows a lack of any significant selling—another good sign. But take note of days when the market shoots up in price to new highs on lighter volume. This shows a lack of institutional buying, which might be a warning sign.

Even in the best of all bull markets, there will be days on the way up when selling suddenly overtakes buying—when an index closes down for the day on heavier volume than the day before. This shows distribution, and it is a potential red flag if that type of action continues to occur.

One day of distribution is not enough to turn a rallying market downward, nor is it necessarily cause for alarm. Rather, take it as a signal to start watching the market more closely to see what happens next. Market cycles over the last 50 years indicate that it usually takes three to five distribution days over a period of up to four weeks to turn the market’s uptrend into a downtrend. Every major market top in the past 100 years has revealed this negative price-and-volume action prior to the market’s downtrend.

Many people think of the great crash of 1929 as being a sudden, inexplicable event. Not so. In late 1929, just before the Dow gave way to a selling avalanche, the index posted a flurry of down days (distribution), each on heavier volume than the previous session, all of them saying to investors: “Get out.” This activity pinpoints the mass exodus by institutional or professional investors—the heart and soul of the market. You might be asking how a market event almost 80 years ago tells us anything about today’s market. The answer is that in the stock market, as in many things, history continually repeats itself because human nature (hope, greed, fear) doesn’t change.

The Nasdaq flashed similar warning signs in the spring of 2000, although almost everyone missed it because they were caught up in the predictions and hysteria of the moment. By March 30, the market had logged a series of heavy distribution days, a sign that a number of mutual funds, pensions or other big players were selling stock. Investor’s Business Daily’s market column “The Big Picture” warned people to get off margin, begin raising cash and only remain invested with extreme caution—not because of what we thought the market was going to do, but because we were reading what the market was actually telling us day by day. It was telling investors: “Sell.”

An investor who remains inflexible during a confirmed market downturn and argues with the market facts will usually suffer the consequences. The name of the game is to preserve profits you have built up in a bull market instead of riding them back down through a bear market period.

by Stock Chartist

I’ve long held the view that beating the market on a long-term basis is more a question of market timing (when to be in and when out) and cash management than superior stock picking. If you stick with the market leaders, try to limit losses from bad picks and move into cash as the market weakens, then you’ll have a good chance of outperforming the benchmark.

But this idea, whether applied to institutional, professional fund managers or individual has been long debated. Mark Hulbert added his view to the argument this past Sunday in the NY Times in his article, “Beating the Market: It’s Still a Tall Order“. Hulbert concludes that “If active management doesn’t acquit itself in a five-year period that includes the worst bear market since the Depression, then it’s yet more compelling evidence that most investors should not even try.”

As evidence for his conclusion, he offers a study from his Hulbert Financial Digest that tracked the performance of hypothetical portfolios set-up by editors of 200 investment newsletters; the editors employed a combination of market timing and sector rotation techniques to decide which funds to buy and sell, as well as when to do so.

Of those newsletters, the eleven that were essentially bear funds performed well during the recent market crash (one gained 75% will the market declined 50%) but lost money over five years preceding the crash so it gained a mere 1%, nearly equal to the Index, over the whole period. According to Hulbert,

“many of the advisers who manage them [bear funds] have been predominantly bearish for a number of years, not just during the bear market. Their model portfolios therefore lagged behind a buy-and-hold approach when the market started rising again. From the beginning of March through December, for example, the 11 model portfolios lost 5.1 percent, on average, versus a 56 percent gain for the Vanguard index fund.”

Hence the conclusion that “performance during a bear market has little to do with long-term returns. Both the best and the worst bear-market portfolios had difficulty beating a buy-and-hold approach over the longer term.”

But what if an investor pursues a long/cash strategy. Tracks the index during up markets and avoids the market during down periods. That’s essential what I attempted to do and, since January 1, 2003, have been able to beat the market by about 80% (the blue line in the chart below indicating the relative performance):

I’m not saying that market timing is easy but it’s not impossible either. I assert based on my experience that if you manage the amount of money you put at risk (by scaling in when the market is in a clear up trend and scaling down as it loses momentum) then, over the long run, you’ll be ahead of a strict buy and hold strategy or a portfolio fully invested in an index fund.

Market timing doesn’t mean predicting the future. What market timing means is finding the major turns in the direction of market momentum and reacting appropriately. Simple indicators for finding those major turns is the Index’s position relative to its 200- and 300-day moving averages.

Being too far ahead of its moving averages is almost as detrimental to forward movement as is crossing over these moving averages. The market today is extended (too far ahead of the moving averages), thus the discussion of a correction (see “More Evidence A Correction Is On The Way“). But a correction doesn’t mean a trend reversal and doesn’t mean you need to dump you holdings. It does mean, however, you should be prepared for a 10-15% correction by hedging or by lighten your exposure to risk (increasing your cash position).