| Volatility and Sharpe ratio are much improved, but the annualized return and maximum drawdown (i.e., peak-to-trough decline on a monthly basis) are disappointingly similar. A large portion of the disappointment can be traced to the severe bear markets of 1973-74, 2000-03, and 2008-09 when correlations among asset classes increased markedly at the worst possible time, resulting in all declining in price at the same time. Faber uses 2008 as a prime example: The normal benefits of diversification disappeared as many non-correlated asset classes experienced large declines simultaneously. Commodities, REITs, and foreign stock indices all suffered drawdowns over 50%. If only there were a way to avoid exposure to risk assets during the most severe bear markets, the problem of converging correlations could be avoided and the diversification benefits of different asset classes with normally low correlations could be fully realized . . . Market Timing Using Moving-Average Crossovers Avoids Crashes Market timing to the rescue! Faber demonstrates that an extremely-simple trend-following system based on the 10-month moving average dramatically reduces the maximum drawdown of any asset class and increases annualized rate of return to boot. For each asset class: - Wait until the market close on the last trading day of a calendar month.
- If the asset's current market price is above its 10-month moving average, invest a full allocation in the asset class for the next month.
- If the asset's current market price is below the 10-month moving average, invest in either cash or intermediate-term U.S. Treasury notes (anywhere between 5-10 years).
- Ignore price fluctuations above or below the 10-month MA during the month – all investment decisions occur only once at the end of the month.
That's it. The results are amazing. As Faber states, the diversification benefits of a five-asset portfolio are turbocharged by market timing with moving averages: The additional advantages conferred by timing are striking. Timing results in a reduction of volatility to single-digit levels, as well as a single-digit maximum drawdown. Drawdown is reduced from 46% to less than 10%, and the investor would have only experienced one down year of less than -1% since inception in 1973. You read that right – over a 40-year period, the portfolio lost money in only one calendar year (2008) and then only by -0.59%! Isn't the ability to sleep at night with such peace of mind incredibly valuable? Of course, hiding your cash in a mattress also would significantly reduce the maximum drawdown and prevent nominal market declines in any calendar year, so the market-timing system is only useful if the annualized return is similar in magnitude to a buy and hold portfolio. Fortunately, it is not just similar – it is higher: 1973-2012 | Faber 5-Asset Portfolio | Compounded Annual Return
(Higher is Better) | Annual Volatility
(Lower is Better) | Sharpe Ratio (Return/Volatility) | Maximum Drawdown | | Buy and Hold | 9.92% | 10.3% | 0.44 | -46.0% | | Market Timing Using 10-Month Moving Average | 10.48% | 7.0% | 0.73 | -9.5% | If you're worried that the humongous decrease in the maximum drawdown only occurs because of commodities or bonds and says nothing about the potential for a stock crash, consider this: since 1900, during the 8 calendar years when the S&P 500 (or its large-cap index equivalent prior to 1957) lost 20% or more, the most-negative return an investor in the S&P 500 using the 10-month MA system ever experienced was -4.6%: | Eight Worst Years
for S&P 500 (or equivalent) Since 1900 | Buy and Hold | Market Timing Using 10-Month Moving Average | | 1931 | -43.9% | 1.4% | | 2008 | -36.8% | 1.3% | | 1937 | -35.3% | -7.7% | | 1907 | -29.6% | -0.1% | | 1974 | -26.5% | 8.2% | | 1917 | -25.3% | -3.0% | | 1930 | -25.3% | 2.5% | | 2002 | -22.1% | -4.6% | | | Where can we send this trade information? | | | It's happening again. Jim Fink is releasing another special trade alert on Tuesday. In it, he'll share a way to multiply a single-digit stock movement into a triple-digit winner. But that's just the beginning, because following his simple instructions each week could double your money 24 times (or more) over the next year. Get the immediate details here. | | | | After seeing this table, how can you ever become scared reading permabears? If they predict the S&P 500 is going to suffer another 40% decline similar to 1931 or 2008, you can just laugh and say "bring it on!" because you will be confident that the 10-month moving average system will totally protect you. Avoiding the "Big Loss" Does Not Sacrifice High Investment Returns And don't feel bad that you will be sacrificing any upside for this peace of mind because you won't be. Between 1901 and 2012, the compounded average return of the S&P 500 using this market-timing system is 10.2%, higher than the 9.3% buy-and-hold return. Given these fabulous results, why doesn't everyone trade stocks this way? Discipline and Long-Term Thinking Is Needed to Follow the System I think the reason the market-timing system is underutilized is because its primary benefit is in avoiding the rare – but deadly – crash, which means that most of the time the system appears unnecessary and a hindrance. The market-timing system can significantly underperform buy-and-hold stock investing during bull markets and trails the returns of buy-and-hold investing slightly more than half the time over the past century. After a few years of underperforming, market-timing investors "give up" and decided to chase higher returns, which usually occurs just before a bear market hits and the market-timing system starts to outperform. Most recently, the market-timing system has underperformed buy-and-hold for four consecutive years (2009 through 2012). How many investors have the discipline to withstand four consecutive years of underperformance and still stick with the system? Over the Next Few Years, Market Timing Should Shine! Since 1973, market timing has underperformed buy-and-hold for four consecutive years two other times: 1977-80 and 1983-86. In both instances, the following four years saw market timing outperform buy-and- hold. If the stock market stays true to form this time around, the next four years (2013-16) will see market timing outperform buy-and-hold yet again. Are you ready? It's easy to follow the market-timing system and right now, the system recommends staying fully invested in U.S. stocks, foreign stocks, and real estate investment trusts (REITs), while cashing out of commodities and bonds. Until stocks fall below the 10-month moving average, permabears should be completely ignored. Lastly, Faber has an interesting video on his website that suggests ways that the market-timing system can be modified to produce even better investment performance. Promising modifications include: (1) using a 9-month or 14-month moving average instead of a 10-month; (2) expanding the number of asset classes from five to 10, but then only investing in the four asset classes with the strongest price momentum; and (3) using intermediate-term bonds instead of cash to park the sale proceeds of asset classes that are currently under their moving average. Even without any complicating changes, however, it's nice to know that the original Ivy market-timing system enables you to easily avoid stock-market crashes without sacrificing the high-return benefits of long-term stock investing. But what if I told you that I've developed a proprietary investment method that makes money in up or down markets, in economic expansions or downturns? Would you be interested? Well, you can access my system today. As chief investment strategist of the premium trading service Velocity Trader, I'm making my followers a "bet." I'm promising to deliver 24 triple-digit winning trades over the next 12 months. If not, I'll cut you a check for $1,950! That's how confident I am in my system. To take me up on my promise, click here now. | 
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