As Stocks’ Returns Dwindle, Market-Timing Draws Interest

Buy and hold has been the only investment strategy most people have needed in the 1990s.

But with the stock market suffering its second major pullback in 12 months, more investors clearly are nervous about the “hold” part of the strategy.

That is shining a new light on the idea of market timing--selling part or all of your stock portfolio and retreating to safer investments, rather than risking far more severe losses than have already occurred.

As different sectors of the market diverge widely in performance, market timing also can mean shifting part of your portfolio into sectors you believe could have significant upward momentum even if the broad market stalls.

For some investors, investigating the pros and cons of market timing “probably makes more sense now than at any other time” recently, said Michael Lipper, president of mutual fund tracker Lipper Inc. in New York.

That might be particularly true for older investors who are concerned about holding on to the huge stock gains they racked up in the now 9-year-old bull market.

Of course, the whole notion of timing the market runs counter to what many people have learned about investing in the 1990s: Buy stocks for the long term and avoid panicking when prices drop, because they are bound to periodically.

What’s more, unless you’re investing via tax-deferred accounts such as a 401(k), timing can generate major capital gains tax bills, which could defeat the very purpose of trying to preserve your capital by timing.

Experts also note that timing means you must make two decisions, and hope you’re right in both cases: “You have to know exactly when to get out--and you have to know exactly when the right moment is to get back in,” said Eric Kobren, president of Kobren Insight Group, a Boston-based firm that provides mutual fund investment advice.

In the fourth quarter of last year, for example, buy-and-hold investors who simply stayed put following the late-summer market plunge saw their stocks rebound quickly.

Standard & Poor’s 500 index stock funds surged more than 21% in the fourth quarter. But timers who were late getting back in--and who missed just the first 18 trading days of the quarter--would have lost out on nearly half the quarter’s total gain.

Still, professional market timers say their goal is largely to limit the volatility of their portfolios while still earning decent returns over time. Most important, they seek to avoid staying heavily invested in stocks when the market is in the midst of a severe decline.

Losing 40% on a stock, timers note, means the share price must subsequently rise 67% just to get you back to even. Better to exit when the stock has lost 10% to 20% and get back in after a rebound has begun, many timers would argue.

With broad U.S. market indexes already down between 5% and 15% from their 1999 highs, during the last month or so many professional timing newsletters have advised clients to cut back on stocks or exit the market altogether.

While there is no guarantee that timing newsletters can call the market’s turns correctly--let alone beat buy-and-hold investing in the long run--they can help investors avoid the problem many face on their own: exiting without having a reentry strategy.

But every timing system is different, and some might entail far more active trading (in and out) than many investors can endure.

Here is a sampling of how some veteran market-timing newsletters are playing the market now. Included are long-term performance results of each newsletter’s primary stock portfolio, as tracked by Hulbert Financial Digest of Alexandria, Va.:

* The Chartist (10-year average annual return: 16.2%; phone: [562] 596-2385) Editor Dan Sullivan, based in Seal Beach, told his subscribers to sell out of U.S. stocks Aug. 11, with the S&P; 500 down 8.2% from its July 16 record high. The S&P; now is down about 9%.

“The market looks very weak right now,” Sullivan argues. In recent weeks, he notes, the number of stocks falling each day has generally far outnumbered those rising--a sign of broad deterioration in demand for stocks.

Because Sullivan recommends an all-or-nothing approach for his followers who use mutual funds--to be fully invested in stocks or to be completely out of the market--they now have 100% of their fund assets in money market funds.

Potential opportunities: Apart from his primary portfolio, Sullivan runs a second portfolio for more aggressive fund investors. For these investors, he’s now recommending a fund that could win big if the market--and particularly tech stocks--tumbles further.

The Rydex Arktos fund ([800] 820-0888) is designed as a “short sale” on the tech-heavy Nasdaq 100 index. A short sale is a bet that prices will decline.

If the Nasdaq 100 stocks dive, the fund should rocket in value. But because those stocks have surged this year, Rydex Arktos has so far been a bomb: It’s down 29%.

“Going short is a very risky proposition,” Sullivan cautions. “You may be able to make money fast--because the markets tend to go down twice as fast as they go up--but even in bear markets, rallies can be spectacular.”

Sullivan’s aggressive-investor portfolio now is 33% invested in Rydex Arktos and two-thirds in cash. For anyone thinking of following a similar approach, Sullivan recommends setting a 4% “stop-loss” on the fund, meaning if you lose 4%, you automatically sell.

* All Star Funds (5-year average annual return: 21.9%; phone: [800 299-4223) Austin, Texas-based Editor Ron Rowland has shifted his timing portfolios entirely to cash in recent weeks.

Like many timers, he is influenced by technical indicators--gauges of the market’s internal strength, or lack thereof. Seeing the S&P; 500 and the Dow Jones industrial average fall below their 200-day moving averages--an important technical indicator of the market’s trend--was particularly troubling, Rowland says.

“It’s time to be a little less greedy,” he says.

Potential opportunities: “I’m expecting to find some very good opportunities in bonds,” or at least Treasury bonds, Rowland says.

With the sharp rise in interest rates this year, bond prices have suffered what may be their second-worst declines in history, after 1994, he says. But he believes that investor anxiety about stocks’ losses and perhaps the Y2K computer bug could push many investors into Treasury bonds in the fourth quarter--driving bond prices up and yields down.

If that happens, a big beneficiary could be long-term zero-coupon Treasury bonds and bond funds, such as American Century Target 2020 ([800] 345-2021). Because zero-coupon bonds in effect pay all of their interest at maturity, the bonds’ prices are extremely sensitive to market interest rate swings.

In 1995, as yields fell after rocketing in 1994, American Century Target 2020 soared nearly 65%.

* Fundline (10-year average annual return: 18.2%; phone: [818] 346-5637) Editor David Menashe began gradually reducing his recommended exposure to stocks over the summer. From a “fully invested” recommendation in July, he now suggests that clients have just 40% in stocks and the rest in money market accounts.

“This has been a difficult market,” says the Woodland Hills-based Menashe, who plans to retire his newsletter next summer.

Why not go entirely into cash? “If I had more confidence that now we are really on the edge of the cliff, I would be tempted to go to a fully cash position,” he wrote in his most recent issue. “But with so many flip-flops [in the market] this year, I’m not ready to throw in the towel just yet.”

Potential opportunities: “I’m not bullish enough to recommend any new buying,” he says.

* Investment Quality Trends (10-year average annual return: 11.9%; phone: [619] 459-3818) “We’ve been in a bear market for quite some time,” argues Publisher Geraldine Weiss in La Jolla. She points to data showing that many more stocks are hitting 52-week lows lately than 52-week highs. In fact, the majority of stocks on both the New York Stock Exchange and Nasdaq have fallen 20% or more from their 52-week highs.

She believes that 70% to 75% of clients’ portfolios now belong in cash, with the remaining portion in high-quality, dividend-paying stocks such as Worthington Industries, a rolled-steel processor with a 3.5% dividend yield currently, or United Asset Management, a mutual fund company with a 4.2% yield.

Better to wait for lower prices before committing more cash to stocks again, Weiss says. Still, “investors should never be entirely out of the stock market,” she says, “because you can never know” when a major upswing will begin.

Potential opportunities: Investors looking for near-term opportunities might consider making a bet on gold stocks, Weiss says. Gold prices, and gold stocks, have resurged in recent days. But the average gold stock mutual fund still is deeply depressed after falling an average of 18% a year over the last three years.

Also, “I’d take a look at utilities,” Weiss says. “When people look for safe havens, they often turn to utilities.”

One caveat: Before you invest in utilities via a mutual fund, check the portfolio. Weiss favors electric utilities, but many utility funds have large stakes in cable TV and telecommunications stocks.

* Systems & Forecasts (10-year average annual return: 8.8%; phone: [516] 829-6444) Earlier this year, Editor Gerald Appel toyed with the idea of going entirely to cash late in the fourth quarter because of fears about how the markets would react to Y2K.

Now he’s more confident in the market’s outlook and believes that cash might begin to move off the sidelines and into stocks, anticipating a big rally early in 2000.

Potential opportunities: Appel, based in Great Neck, N.Y., figures that if a rally begins soon, the market’s recent leaders--technology and biotechnology stocks--will remain in the lead. “If the market picks up strength, that’s probably where it will go,” he says.

Because the tech sector hasn’t suffered a major pullback, though, a less risky way to play an up market might be through high-yield junk bond mutual funds, Appel argues. Junk bonds, while sensitive to market interest rate shifts, also are highly sensitive to stock market moves. Why? Because companies that issue junk bonds may be viewed as less risky--raising demand for their bonds--if they also can raise financing via new stock issuance.

* Fundadvice.com (10-year average annual return: 9.7%; phone: [800] 423-4893) Editor Paul Merriman, based in Seattle, recently recommended that clients using his stock fund timing portfolios have 75% of the stock portion of their portfolios in cash.

“My feeling is that there are going to be great buying opportunities during the quarter,” he says. But “you have to be patient.”

Potential opportunities: Like Rowland, Merriman says one could make a decent case for depressed zero-coupon bonds.

As for stocks, “I think a person almost has to say, ‘Look, I’m not going to know where the exact bottom is going to be,’ ” Merriman says. Better to decide in advance that if the market or individual stocks fall to certain levels, you’ll begin nibbling, he says.

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