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It's Time to Time the Market

Trying to "time" the market is risky. But as stocks and bonds sit near record highs, investors might want to consider some version of it.

Merely to suggest market-timing is to reject generations of advice. "Don't try it—ever," warned Charles Ellis in his investment classic "Winning the Loser's Game," calling it a "wicked" idea.

John Bogle, founder of Vanguard Group, noted in his book "Common Sense on Mutual Funds" that "after nearly 50 years in this business, I do not know of anybody who has done it successfully and consistently…I don't even know of anybody who knows anybody who has done it successfully and consistently."

Studies show that most investors who try to time the markets fail, buying high and selling low. Yet it is possible to glean meaningful clues from current indicators—and tweak portfolios for the longer term.

Which brings us to today. U.S. Treasurys and stocks seem expensive by historical standards. To stay fully invested is to risk mediocre returns.


Treasury bonds are almost certain to lose. Ten-year Treasurys boast a yield of just 1.8%, while the bond market is forecasting inflation of about 2.5%, based on the difference in yields between inflation-adjusted and regular Treasurys. If that plays out, a Treasury investor will have less purchasing power in 10 years—a de facto loss.

Over the past 80 years, according to data from New York University's Stern School of Business, bond investors have earned an average of just over 2% a year, adjusted for inflation. The only way an investor would earn anything similar over the next decade would be if inflation were negative.

Stocks, too, seem pricey. Over the past 130 years, U.S. stocks on average have traded at about 17 times mean earnings for the previous 10 years—a measure known as the "Shiller Price/Earnings Ratio" after Yale economics professor Robert Shiller, who tracks the data. Today the market is about 22 times those earnings, a level associated with frothy markets such as 1929, the mid-1960s, and most of the period from 1995 to 2008.

Another measure, "Tobin's q," also suggests stocks might be in dangerous territory. Tobin's q, named for the late Nobel economics laureate James Tobin, measures stock valuations against the cost of replacing companies' assets. Right now the reading is 0.92, about 50% above the long-term historical average. Stock returns from these levels have usually been subpar.

"Equities and bonds in America are seriously overvalued," says Andrew Smithers, chairman of London-based financial consultancy Smithers & Co. Fund company GMO, with $100 billion under management, predicts meager returns over the next seven years from U.S. bonds and most U.S. stocks.

So what should nervous investors do to position their portfolios for the years ahead?

Mr. Smithers suggests lowering stock and bond exposure, and holding more cash instead, even though short-term interest rates today are below inflation. "People underrate cash," he says. "The point of cash is to avoid losing money."

He says keeping 20% of your portfolio in cash, and either buying or selling stocks and bonds each year to maintain that ratio, has historically been a smart move for most private investors: It has cut your risks more than your returns.

Rob Arnott, chairman of Research Affiliates, an investment advisory firm, suggests diversifying into emerging markets and high-yield bonds. Emerging-market stock prices have lagged behind those in the U.S. over five years, and Mr. Arnott says valuations there are now considerably more attractive.

As for high-yield bonds: Yes, average yields have recently tumbled to record lows. But Mr. Arnott says the bonds remain attractive, especially in comparison to Treasurys, whose yields have all but vanished. The average high-yield bond currently yields 5.3 percentage points more than comparable Treasurys, according to the Federal Reserve. That isn't much less than the median gap since 1996 of 5.5 points.

Low-cost options for these include the Vanguard MSCI Emerging Markets exchange-traded fund, with an 0.2% expense ratio, and the SPDR Barclays Capital High Yield Bond ETF, JNK 0.13 % with an 0.4% expense ratio and a 5.7% yield.

The go-anywhere All-Asset All-Authority mutual fund, which Mr. Arnott manages for Pimco, has gained 105% since it was launched in 2003, according to Lipper, handily outperforming both U.S. stocks and bonds. The $24 billion fund fell just 7.5% in 2008. It isn't cheap, however: Net fees are 1.5%.

Keep in mind that investors who are right about long-term valuations can first be wrong for years. U.S. stocks looked cheap for most of the 1970s before starting a sustained rise in 1982. U.S. stocks looked expensive for most of the late 1990s; the bubble didn't burst until 2000.

That is all the more reason why it is probably better to tinker with your portfolio right now than overhaul it.

Write to Brett Arends at

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