I personally view market timing as something to consider but also something that only works if you don't try to do it too often. It is analogous to something that comes up in trying to control engineering systems when there is randomness. Basically, if you try to put in control inputs too often you end up introducing more volatility. But if you never put in control inputs you just accept the randomness.
I have a hard time with this concept. While bubbles are recognizable, it's impossible to determine when they'll burst. As the saying goes, "The market can remain irrational longer than you can remain solvent." Or something like that. Too lazy to look up the exact quote.
Here's an example. During that record bull market that started in the 80s, a bubble was recognized. On December 5, 1996, Greenspan stated:
Clearly, sustained low inflation implies less uncertainty about the future, and lower risk premiums imply higher prices of stocks and other earning assets. We can see that in the inverse relationship exhibited by price/earnings ratios and the rate of inflation in the past. But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade?
So a bubble was clearly foreseen. And yet that bubble didn't burst until March of 2000, over 3 years later. A prudent man would have bailed from the market after Greenspan's comments -- and missed out on some huge gains.
Imagine floating down a river in a kayak. You know there are rapids ahead. You know if you just sit and do nothing you'll get to the end just fine. There is truly nothing wrong with just sitting there and going with the flow. But most people will try to avoid the worst rapids by doing their best to predict where they are and stick to the calmer areas when they see them coming and move into the faster moving water when it is safe. But the guy who constantly goes back and forth across the river trying to find ever patch of quick water will probably waste a lot of effort and ultimately fall behind.
Not so. It's a bad analogy and in this case, as a former certified whitewater guide, I know what I'm talking about. In the case of the river, you can see exactly where the rapids are. Your expertise is in determining what rapids are safe to risk yet provide the returns (in the form of thrills) that your clients are paying you for. At the same time, they rely on your judgement to avoid unacceptably high risks. I don't think this same kind of expertise is possible in the financial markets.
The analogy is closer than it might seem at first. Most criticisms of market timing focus on assuming it is impossible to predict markets because they are random. A lot of great thinkers came to believe that and a lot of market theory was formulated in the 1950s, 60s, and 70s based on that fundamental idea, including academic work by Malkiel who has been mentioned here. But since then we have developed tools to understand, characterize, and even predict (in a probabilistic sense) the behavior of random processes. We can launch a rocket violently from earth and somehow get a lander to the surface of a distant moon within a few millimeters of where we intend at a time within less than a second of our plan. That's not to say there wasn't a lot of randomness and unpredictability along the way.
I could give many more examples. And it is all literally built on the same math that describes stock market behavior.
I believe in math. However, the application of math is applied by humans and interpreted by humans, which can be and has often proven to be flawed. That's why quants don't seem to do any better than the market over the long term. There's a long list of hedge funds that have gone under because they got the math right, but didn't know what it meant. One of my favorite articles in the past few years was published in Wired Magazine, and is called Recipe for Disaster: The Formula That Killed Wall Street
. DH, I think you'll really enjoy reading it. Let me know what you think.