Friday, October 5, 2012

How the big boys time the market

This is a portion of an annoying item that appeared in the Globe ROB 
PAUL BRENT - Special to The Globe and Mail - Published Thursday, Oct. 04 2012

Quote: “the chart and data-heavy approach of Peter Gibson, CIBC’s top-ranked head of portfolio strategy and quantitative research, provides both a guide to portfolio balancing and market timing.

The basis of CIBC`s asset allocation strategy is deceptively simple. Since 1998, every time bond yields fall, stock prices fall, and every time bond yields rise, in general, stock prices also rise in lockstep. What CIBC tries to do is predict the ceilings for the 10-year U.S. treasury bonds.

“The bond yield ceiling right now is 3.65 [per cent],” Mr. Gibson said. “If the bonds were to rise to that level then the stock market becomes overvalued and then we have to switch our exposure back into bonds.”

CIBC used this analysis to detect and act upon a buy signal for equities in 1998, a sell signal at the beginning of 2000 during “the peak of the tech mania,” a buy signal in October, 2002, and a sell signal again in June, 2007. CIBC also sent out a buy signal in January of 2009, but “we were a little bit early,” he said.

What’s important about the years 2000 and 2007, when the markets crashed, “was that at the same time we were hitting the ceiling for bond yields, suggesting that bond yields are too competitive with stocks. We also have falling profitability because the Fed is tightening, trying to stop the bond yield from rising,” Mr. Gibson explained.

“So the return on investment begins to fall, meaning bond yields are too competitive and corporate profitability is falling,” he said. “You have no business being in the stock market.”

The result was two stock market collapses of roughly 50 per cent. Meanwhile, because bond yields were falling, bond prices rose and bond total returns rose 37 per cent while the market fell 50 per cent. In 2007-2008, the bond total return was up 20 per cent while the stock market was down 57 per cent.

“This is how we time the market,” Mr. Gibson explained.

“By switching just five times, from 1998 to 2009 – stocks, bonds, stocks, bonds, stocks – you are doing almost an 18 per cent per-annum return” in Canada, with a rotating split between 100 per cent stocks and 100 per cent bonds, Mr. Gibson said. “Basically you could play golf the rest of the time. It is because first and foremost you have this positive correlation between bond yields and stock prices.”

Stock picking is less important with this strategy, given that 60 per cent of a total return from individual stocks is a function of the market rising or falling, not a stock`s fundamentals, CIBC states.

Today, CIBC’s data shows “right now the stock market is incredibly cheap, based on the level of interest rates,” he said, and CIBC is recommending that investors should be overweight in stocks.

CIBC had noticed in recent months that corporate profitability was beginning to fall and predicted (rightly) that a co-ordinated program of quantitative easing would occur in the Europe, China and the United States.

“That is what has lifted this market,” Mr. Gibson said. “It is due to a policy shift, though. It is not due to strong and sustainable profit growth. If I had sustainable profit growth with the interest rate picture that I have, I would probably be talking about 1700 on the S&P.”
End Quote:

Now – back to reality. Aside from the arrogant insinuation that the “big boys” are smarter than us “small boys”, market timing implies that investors should dump their investments when they get a “sell” signal from some seasonal or black box strategy and then buy them back when a “buy” signal is generated. In the example of the CIBC model 

Mr. Gibson says “every time bond yields fall, stock prices fall, and every time bond yields rise, in general, stock prices also rise in lockstep”.

There is also one minor problem with the Gibson / CIBC timing model. If Peter Gibson only joined CIBC in 2009 how could he be a component of any CIBC model buy and sell signals from 1998 through 2009?

I display a long term monthly data plot of the 10-year U.S. treasury bonds above the S&P500 and I have marked the CIBC buy & sell signal with up & down arrows. Note the 1992–1998 period where the relationship failed and note the 2010–2012 period where the relationship also failed.

This timing model needs two things to work, firstly the yield vs. S&P500 signals has to be a fact (which is questionable) and secondly you need to get the yield (upper plot) buy & sell calls right as marked by those up & down arrows. Are we to believe the CIBC got all those yield calls right? A posted comment sums it all up: gazous - 1:32 PM on October 4, 2012 - easy enough, after the fact....


Piazzi said...

I thought you might enjoy this write up on the one and only O'Leary said...

Hello Piazzi

I only ever met Kevin O’Leary once – it was in makeup just before we were to do a brief ROBTV shot from the studios at the Globe on Front Street. It was during the end of the .COM and post 911 market melt-down. The guy was almost in tears – trembling in fear of the stock market chaos – I tried to calm him down only to see him get in front of the camera suddenly change into a raging bull.

I don’t know if O’Leary has money but for sure is was not from skilled portfolio management