Market Timing, Tactical Asset Allocation, And Trading: A Dialogue

Here’s a dialogue between two sides of myself: Moses, who’s a proponent of market timing and tactical asset allocation (TAA), and Celeste, who thinks it’s bunk.

Moses: What is the difference between trading, tactical asset allocation, and market timing? In all three cases you’re buying and selling assets that are designed to be held for far longer than the amount of time you’re holding them.

I’m a stock picker. I very rarely hold stocks longer than nine months. I place buy and sell orders every week, sometimes every day. I’ve been able to consistently beat the market, with a CAGR of over 40% for more than three years, by using a ranking system on Portfolio123 to invest in microcaps.

Now if I were to do exactly the same thing with a limited number of ETFs, buying and selling them at different times, I would be doing TAA instead of trading. And if I were to limit myself to just two ETFs, SPY (which tracks the S&P 500) and ICSH (which tracks short-term government bonds), I’d be doing market timing.

So my gut tells me that all those pundits who say that buy-and-hold always beats market timing are the same pundits who say that index funds always beat stock-picking. And if they’re wrong about the latter, why shouldn’t they be wrong about the former?

Celeste: People have been trying to do market timing for over a hundred years and nobody yet has gotten it right. If someone were to get it right, beautifully timing her entrances and exits so as to altogether miss every correction and every bear market but capture entirely every major upswing, she would basically rule the world. Why? Because enough people would follow her lead that she’d be able to effectively manipulate the entire stock market and make more money than anyone in history.

Let’s say she times the market impeccably for twenty-five years, becoming famous in the process. Let’s say that 75% of the investment world doesn’t believe her predictions despite her amazing success, but 25% does.

Now let’s say that she predicts that the stock market will take a downturn sometime in the next few weeks. 25% of investors will sell all their stocks, resulting in a massive downturn. Several months later, she predicts that the downturn is over, and that stocks will shortly stage a massive recovery. 25% of investors will promptly buy stocks, sending the market soaring again.

In other words, the more successful a market timer is, the more impact she will have on actual stock prices, making her prophecies self-fulfilling.

This conclusion won’t have escaped her. She will very quickly realize that she can sell her own personal holdings, then predict a stock market downturn. Stock prices will tumble. She can then buy up huge quantities of stock and predict an upturn. Stock prices will soar, and she’ll make a tidy profit. The more often she makes her predictions, the richer she will get.

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