Maybe You Can Time the Market

Soon I shall be shuffling off this little column and leaving you to the tender mercies of other observers. But before I do, I want to share with you in a very general way the debunking of a myth about the validity of "buy and hold" and the supposed inability of investors to time the market.

One of the great selling tools of stockbrokers is that it is impossible to time the market -- that is, to buy at a specific time when you get better investment results than buying at any other time. The supposed rule is that we never know when to buy and when to sell, so we might as well just keep buying all the time.

If true, this is good news for brokers. It also happens to fly in the face of all common sense. Why would there be a good time to buy and sell real estate, commodities, collectibles and bonds, but not a good time to buy and sell stock? Surely stocks are cheap at some times and expensive at other times.

Reviewing History

Well, I have just seen the preliminary results of a study by my investment guru pal Phil DeMuth that I think pokes a major hole in that "you can't time the market" baloney.

Dr. DeMuth took all of the seven-year periods in the Dow Jones Industrial Average since 1960. He assumed that an investor made a buy of $100 worth of the Dow from the beginning of that period until the end of 2001. The investor, as you might think, made an excellent return.

Then Dr. DeMuth made a different assumption. He computed the trailing price-to-earnings ratio of the Dow for each seven-year period before each month. If the P/E in that month were one standard deviation less than in the prior trailing period, he bought $200 worth of stock. In the other months, he bought nothing. (A standard deviation is a range within which two-thirds of all the reported results fall. Thus, buying at lower than one standard deviation below the trailing P/E would mean buying when the P/E was unusually low.) The results gave that investor roughly twice the percentage gains that the dollar-cost-averaging guy received.

If the investor then cleverly sold $200 worth of stock in every month in which the P/E was greater than one standard deviation above the seven-year trailing P/E, his percentage return would more than double again.

It's Not Rocket Science

I don't want to claim too much. It may be that future results will vary. And I do not want to claim too much credit. I did suggest to Dr. DeMuth that he do this research, although he chose the exact parameters of each regression. But the basic idea -- that stocks are sometimes more of a bargain than at other times -- is not rocket science, except to people whose livelihood depends on constantly selling stocks.

John Bogle, late of Vanguard, made similar calculations 10 years ago. He found that when stocks were paying a larger dividend than usual as a percentage of price, their return over the next decade tended to be above average. When the return of stocks as measured by dividends was below average, returns over the next decade tended to be below average. (Great differences in yields yielded great differences in total return over the succeeding decade.) And of course, Warren Buffett says he makes similar calculations, although I wonder.

Today, with earnings yields and dividend yields at uniquely low levels, a conclusion is suggested: Stocks in general are still too darn high to offer a good return over the next many years.

Luckily, there are bonds, real estate and cash.

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Benjamin J. Stein has been a trial lawyer, a White House speechwriter for former Presidents Nixon and Ford and a campaign speechwriter for Reagan. He has been a columnist for The Wall Street Journal and written for publications including Barron's, New York magazine and Los Angeles magazine. He is a novelist, a nonfiction book writer and a screenwriter, and he has been an expert witness on financial fraud. He studied economics and finance at Columbia University, where he graduated with honors in economics in 1966. He studied finance at the graduate level at Yale while he was a law student there and served as an economist with the Department of Commerce before commencing his work as a trial lawyer. His work on ethical issues in finance has been widely published, especially as it related to the Drexel Milken junk bond scheme and to the problems inherent in management buyouts of public companies. He has also written frequently about the problematic nature of mergers and acquisitions of public companies and about the deep ethical problems of accountants of public companies. His book on Drexel, A License to Steal, addresses many of these issues. He speaks frequently to financial and lay audiences about issues in finance and ethics, usually from a humorous perspective. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. At time of publication, Stein held no positions in any of the securities mentioned in this column, although positions can change at any time. While Stein cannot provide investment advice or recommendations, he invites you to send your feedback to Ben Stein.