Gurus are Inaccurate Too Often

How often does a market-timing guru need to be right to beat an index? Nobel Laureate William Sharpe set out to answer that very question in his 1975 study titled, "Likely Gains from Market Timing."1 Sharpe wanted to identify the percentage of time a market timer would need to be accurate to break even relative to a benchmark portfolio. He concluded a market timer must be accurate 74% of the time in order to outperform a passive portfolio at a comparable level of risk. In 1992, SEI Corporation updated Sharpe's study to include the average 9.4% stock market return from the period 1901-1990. This study determined that gurus must be right at least 69% and as high as 91% of the time, depending on the timing of the moves.2

What percentage of times do market timing gurus get it right? CXO Advisory Group tracks public forecasts of self-proclaimed market-timing gurus and rates their accuracy by assigning grades as "correct," "incorrect" or "indecisive." Figure 4-1 depicts CXO's percentage grades for 28 well-known market-timing gurus who made a collective 4,629 forecasts from 2000 - 2012. The study shows that not one of the self-proclaimed gurus was able to meet Sharpe's requirement of 74% accuracy, or SEI's minimum 69%, thereby failing to deliver accuracy sufficient to beat a simple index portfolio3.

Figure 4-1

At first glance, the 10 gurus who had percentage accuracy of more than 50% might look appealing to a time picker—but beware, the opportunity costs associated with a time picker's proclivity toward holding cash in some up years creates a higher hurdle as they will have to make up those higher returns foregone by stocks. Transaction costs associated with market timing add another hurdle for market timers to break even.

In The Big Investment Lie,4 Michael Edesess explains why market timing is so difficult, "The stock market can turn on a dime and always does. Prices are constantly twisting and turning without trend or predictable pattern. Their recent movement gives you nothing to go on."

    -1 William Sharpe, "Likely Gains from Market Timing," Financial Analysts Journal, vol. 31, no. 2 (1975).
    -2 "Technical Note: Calculation of Forecasting Accuracy", SEI Corporation position paper, April 1992.
    -3 "Guru Grades", CXO Advisory, March 31, 2014,  http://www.cxoadvisory.com/gurus/, Copyright: CXO Advisory Group LLC:Reproduced with permission.  Due to space limitations, we limited the chart to gurus with more than 100 forecasts for the period ending Dec. 31, 2012
    -4 Michael Edesess, The Big Investment Lie: What Your Financial Advisor Doesn't Want You to Know (San Francisco: Berrett-Koehler Publishers, Inc., 2007).
Step 4William SharpeCXO Advisory GroupThe Big Investment LieMichael Edesess