Time To Buy?

An Alarm Is Blaring: Time To Buy

By Mark Hulbert | 21 May 2008

Market timing— trying to jump into or out of the stock market just before rallies and declines— is notoriously difficult. Most investors would probably be better off sticking with a buy-and-hold strategy. Nevertheless, anyone trying to beat the odds may be interested in a market indicator with an excellent track record— and it has just flashed a buy signal. Of course, it is just one signpost, so proceed with caution. But it may help shift the weight of market evidence toward the bulls.

Called the Recession Buy Indicator, it was devised by Norman Fosback, who was editor of Mutual Funds magazine in the 1990s and the author in the mid-1970s of the popular investment textbook "Stock Market Logic." He currently edits Fosback’s Fund Forecaster, an investment newsletter. The indicator is based on the notion that it is darkest just before the dawn— that when the economic news becomes bad enough, the stock market’s likely subsequent direction is up. Because the stock market is forward-looking, Mr. Fosback said in the most recent issue of his newsletter, it "has little use for yesterday’s, or even today’s, crises."

"The focus," he added, "is always on the future— how will business be six months, or a year or two, from now?" When the economy appears to be on tenuous ground, as it does today, he said, "stock investors looking well out to the future are able to perceive the seeds of the next economic expansion." It is one thing to appreciate this market cycle from a conceptual point of view, but quite another to come up with a market-timing system based on it.

Mr. Fosback’s indicator focuses on the four business barometers that together make up the federal government’s index of coincident economic indicators. These four focus on industrial production, manufacturing and trade sales, nonfarm payrolls and personal income. The Recession Buy Indicator is triggered when— as is the case today— each of these four gauges is below its level of six months earlier. On such occasions, Mr. Fosback considers the economy to be in a recession or very close to it.

He came up with this indicator in 1979, and since then it has set off four buy signals (not counting the current one). On average over the 12 months following those signals, according to his research, the average stock on the New York Stock Exchange had a total return of 37 percent. And in the three years after such a signal, the average gain was 106 percent. These gains are triple the stock market’s long-term average.

(Mr. Fosback has also backtested this indicator to the late 1940s, the earliest period for which data on the coincident economic indicators were available, and it performed just as well from then until the late ’70s as it did in more recent decades.) NOT everyone draws the conclusions that Mr. Fosback does. Ned Davis Research, an institutional research firm based in Venice, Fla., has extensively studied the stock market’s performance during and after United States recessions since World War II.

Like Mr. Fosback, the firm’s analysts found that the stock market typically hit bottom six months after a recession began, and that at such times the stock market was a "table-pounding buy." But, in an interview, Ed Clissold, the firm’s senior global analyst, cautioned that this conclusion was based on an average, and that on some past occasions the stock market’s actual bottom came much later. That is one reason, he said, that his firm doesn’t mechanically issue a buy signal six months after the economy begins to turn downward. Instead, it prefers to await confirmation from a number of its other indicators that a bottom has been formed. In the current market, that confirmation has not yet come, he said, and his firm has a policy of not trying to predict when it will.

The advantages of not automatically jumping into the market six months into a recession were clear the last time the Recession Buy Indicator flashed: in February 2001, a year and a half before the low of the 2000 - 2002 bear market. In his latest newsletter, Mr. Fosback acknowledged that this particular signal was "the poorest performing of the 10 signals" since World War II. Even so, he argued, the average stock was still higher three years later.

He agreed that many people might be wary of plunging into the market when the economic news is so bad. But, he added, his indicator is a classic illustration of the virtues of contrary opinion: "When everything seems gloomiest, it’s time for the smart money to buy."

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Normxxx    
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