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Timing the Market: Proper Revival or Let it Rest in Peace?

Valuation is the Achilles Heel

By William Hester, CFA
October 2003

A funny thing happened in the pool of suds left by the stock market bubble. Market timing gained some luster. Not because investors could claim success at it; mutual fund outflows were heaviest in 2002, the third year of the bear market. Call it a natural reaction to so much money being lost in so little time.

The Street is talking about it. The Wall Street Journal recently covered the uproar caused by the renowned investment advisor Peter Bernstein when he spoke about timing investments into and out of the stock market at a conference earlier this year.

Investment writers have the bug too. Market-timing books are flying off the presses. No fewer than four books have been published on the topic this year, more than through the entire bear market, according to This year's list includes 'All about Market Timing' and 'The Complete Idiot's Guide to Market Timing' (maybe society's best barometer of hot topics).

One of the other new offerings, 'Yes, You Can Time the Market', provides interesting data for the discussion. The cover depicts the two authors poolside, surrounded by bars of gold. When I first picked up the book, I figured it was another get-rich-quick strategy, three years after the get-rich-quick era abruptly came to an end. After a few pages it became apparent that the title and cover shot were created to sell books, and the text was written to guide investors. In the end the book has some simple but sound advice.

Ironically, investors seeking support for market timing will be disappointed. 'Yes, You Can Time the Market' doesn't try to bolster market timing's case. In fact, it shows that market timing, at least by the traditional definition where investors move deftly in and out of markets, can be frustratingly difficult. The book focuses on timing long-term buy and hold decisions, an important distinction.

Buy Low and Behold

The highest long-term returns come from buying stocks when they're cheap and holding them for long periods of time, argue the authors. Though that statement seems inherently logical, they correctly point out that during the 1990's investment pros instructed the investment public to buy at any price This was because trying to time the market seemed so futile during the nearly two-decade bull market. The studies in 'Yes, You Can Time the Market' go back a century, and their results show otherwise.

The authors looked at simple measures of value, and tested strategies that bought stocks when they were cheap (compared to recent history), and then held them for various periods. These results were compared to buying stocks when they were expensive and holding them for the same periods.

The stocks were held for 5, 10, 15 and 20 years. The holding periods that began during rich markets were averaged, as were the holding periods that began during cheap markets. (All the returns were adjusted for inflation, to assist the comparison of nearly 100 years of data).

In one test the authors compared the Price/Earnings ratio of the market to its 15-year moving average (a "moving" average moves by adding the most recent number and dropping the oldest - you simply add up the values over some number of periods and divide by the total number of observations). Stocks were deemed expensive when P/E ratios were above their 15-year moving average; cheap stock markets stood below this average.

Now, comparing the current P/E to its 15-year moving average is about the simplest trading rule you can construct. So what were the results? Ten, fifteen, or twenty years after buying stocks when they were cheap generated substantially higher returns than buying stocks when they were expensive. And the longer you waited, the larger the difference in performance between the two strategies. Other stock value yardsticks showed similar results.

The authors didn't stress one of the most interesting findings of the book. Looking at P/E's the authors found that over the average five-year period, buying stocks when they had high P/E's slightly outperformed stocks bought at low P/E's. (Other studies the authors performed showed the opposite result, but most of the outcomes over a five-year period were quite close.)

This is what stymied so many smart investors through the second half of the 1990s. If you thought that overvalued markets would go down immediately, your returns suffered dramatically from 1996 through 1999. Fairly valued markets get overvalued; overvalued markets can turn into bubbles.

And that is one of the great lessons from the late 1990's: valuation is an untrustworthy guide when looking out just a few years. This is what makes market-timing such a frustrating and often futile endeavor. If what you pay for a security has so little forecasting power over the short-term, market timers focused on only valuation can be easily misled.

The Fund Information page explains the distinction between market timing and the Market Climate approach used by the Hussman Funds.


The foregoing comments represent the general investment analysis and economic views of the Advisor, and are provided solely for the purpose of information, instruction and discourse.

Prospectuses for the Hussman Strategic Growth Fund, the Hussman Strategic Total Return Fund, the Hussman Strategic International Fund, and the Hussman Strategic Dividend Value Fund, as well as Fund reports and other information, are available by clicking "The Funds" menu button from any page of this website.

Estimates of prospective return and risk for equities, bonds, and other financial markets are forward-looking statements based the analysis and reasonable beliefs of Hussman Strategic Advisors. They are not a guarantee of future performance, and are not indicative of the prospective returns of any of the Hussman Funds. Actual returns may differ substantially from the estimates provided. Estimates of prospective long-term returns for the S&P 500 reflect our standard valuation methodology, focusing on the relationship between current market prices and earnings, dividends and other fundamentals, adjusted for variability over the economic cycle (see for example Investment, Speculation, Valuation, and Tinker Bell, The Likely Range of Market Returns in the Coming Decade and Valuing the S&P 500 Using Forward Operating Earnings ).

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