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Can you forecast the market?

Market timing isn't for everyone. But there are lessons to learn from professionals putting up impressive numbers - and challenging conventional wisdom.

By Eric TrosethSpecial to The Christian Science Monitor / October 20, 2003



Forget for a moment all conventional wisdom about investing - all the "expert" advice, mutual-fund newsletters, and so on - and consider this question: Can investors successfully "time" the market, buying and selling at appropriate points to boost their returns and reduce their risk?

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Most financial advisers say it's almost impossible - and certainly beyond the reach of the average investor. But a small group of professionals is challenging that notion by outperforming the market, including one investment adviser who practices what he calls "climate investing."

It's an intriguing idea. You adjust your portfolio to the market climate in much the same way you change your wardrobe to fit the season. You still can't predict next week's close, the adviser says. But if it's wintertime in stocks, you're more likely to need a wool coat than a T-shirt. His long-term outlook: Grab that coat. There's a chill in the air.

"Stocks are not cheap here and therefore are likely to deliver below-average long-term returns," says John Hussman, chief practitioner of climate investing and manager of the Hussman Strategic Growth Fund and the Hussman Total Return Fund (www.hussman.net). His strategic growth fund ranks No. 1 in three-year performance (out of more than 5,500 diversified domestic funds) when measured by the Sharpe ratio. The ratio gauges return according to the risk taken to achieve the return.

Hussman believes investors should trim their exposure to stocks until the climate improves. About half his strategic growth fund is hedged in case the market declines.

Such advice runs counter to mainstream investment thinking. And there are good reasons for skepticism. But the best strategists and market timers are worth heeding because they challenge the heart of conventional market theory.

Conventional wisdom holds that the market almost always works efficiently. In other words, stock prices move up and down because investors make rational decisions based on changes in company earnings, economic conditions, and so on. But if the market moves to extremes in ways traditional market theory can't explain, then other approaches may offer more profit and less risk.

Investors as watchdogs

According to Hussman, keeping the market efficient is like trying to make a hyperactive sheep stand on a nickel. You might succeed for a while, "if you have a lot of sheepdogs that are hungry and inspired and willing to correct every deviation. But if the sheepdogs ever begin to believe that the sheep will stay on the nickel by itself, then that sheep may not even remain in the neighborhood."

Frequently, it seems, investors don't make good watchdogs. Instead of refusing to buy unless values are reasonable, they tend to buy stocks "as though they were buying lottery tickets or betting on a horse race," Hussman says. "What distinguishes a [true] investor from a speculator is an investor asks: 'Where is the value? And what is the price?' "

That's true enough, skeptics say, but as a group, market timers haven't performed very well. Indeed, some studies suggest the majority of fund managers even fail to match market indexes. That's why index funds, which simply try to match the Standard & Poor's 500 or some other index, often do as well or better than actively managed funds.

By contrast, Hussman's strategic-growth fund is up 65 percent since its inception in July 2000 through a carefully constructed mix of value investing, hedging, and timing strategies. Remarkably, its largest decline from peak to trough has been about 7 percent. By comparison, the S&P 500 is down about 25 percent during the same period, and holders of S&P 500 index funds have endured a painful peak-to-trough drawdown of about 49 percent.

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