Monday, June 19, 2006

Blog of the Week: Abnormal Returns

Market timing follies

Is market timing using widely used, publicly available data possible? One widely-used model, the Fed model, has largely been discredited on a number of grounds. That is not going to stop many analysts from trying to generate market-timing models - the potential gains are simply too big. One need only look at this graph from Ticker Sense to see the attraction in market timing.

We noted yesterday a piece by Mark Hulbert in the New York Times that examines a market timing model derived from the Value Line Investment Survey. Barry Ritholtz spends some more virtual ink on the model and admires the fact that the inputs into the model are "unbiased and uncorrupted." Those are indeed admirable qualities and the Value Line based model is an interesting one.

Although we have mentioned it previously some analogous data is also available from Morningstar. Like Value Line, Morningstar has dozens of analysts who generate fair value for hundreds (if not thousands) of companies using a consistent process. Morningstar compiles the deviation from fair value for their universe in a series of graphs. As you can see the model dipped decisively into undervalued territory last week which coincided nicely with the bounce we saw. We do not remember seeing any statistical work done on this measure, in part because it has a shorter history than the VL system, but it would be worth examining.

Paul Kedrosky (via pointed to a (soon to be) published paper by Kenneth L. Fisher and Meir Statman, "Market Timing in Regressions and Reality" (pdf) that compares the market timing ability of valuation based measures, like P/Es and dividend yields, against sentiment measures. While they find the sentiment measures superior to the valuation measures, neither were particularly useful. This may be due in part to...

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