Wednesday, February 02, 2011

Two cycles complete

I began investing in the stock market in the late 1990's with very little idea of what I was doing. The 2000-2002 bear market then discouraged me so much that I stopped paying attention for several years. By 2005 the S&P 500 index had returned to my original investing starting point, and I started paying attention to stocks again, this time with the intention of learning how to time the market. Cycle 1 was complete.

By 2007 I'd learned enough to cash out (temporarily) at the precise market peak in October, and to switch to a bearish stance by January 2008. It was during the 2007-2009 bear market that I learned one of the most important lessons in market timing: stock valuations (P/E ratios) are meaningless. However, as I'm sure many people have done in previous bear markets, I found reasons to believe that "this time it's much worse than before", and could not get myself to take a bull market stance when prices turned around in 2009. The housing market was still tanking, the derivatives market was a house of cards, the federal government was $13 trillion in debt, unemployment was hovering around 10%, and our first socialist president had just been elected - I was surprised that enough people still had spare funds with which to buy stocks. (To be fair, I also had some career issues in 2009 and 2010 that contributed to my lack of attention to the market.) However, in the subsequent rally that's still going on, I've finally seen first-hand that the stock market is blind in both directions, and that a rally can occur despite obvious economic warning signs. The S&P 500 index is now back to the point where I originally started thinking about market timing. Cycle 2 is complete.

In hindsight, my biggest market-timing obsession - and my biggest obstacle to making a straightforward mathematical timing model - was to find a method that would turn bearish before a stock market crash like the one on October 19, 1987. I found a method alright, but it was difficult to integrate it with the schemes that worked better during the remaining 99% of the stock market's history. I think that finding such a method was more a point of pride than it was a way to improve returns, since such crashes are exceedingly rare, and because I already knew of signals that would at least tell me to cash out to a neutral position before that particular crash. I'm not worried any more about being bearish before the next 20%-in-one-day crash - I'll be happy to be in cash if it happens again.

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