William F. Johnson

Measuring Market Timing: An InternationalExamination of Market Timing Conditions

The objective of this article is to introduce an expost measure of market timing independent of luck or skill in order to identify when market conditions are more favorable to successful market timing and to evaluate the conclusions of several previous academic studies. We propose that basic market conditions rotate from favoring buy-and-hold investing to favoring market timing strategies, and that these conditions can be measured in any equity market by tracking the results of a constant skilled market timer. We seek to identify what market return conditions are more conducive to successful timing for this constant-skilled investor and when these conditions have been present over our sample period. The MTBH metric was calculated for 44 countries for 14 years and compares findings of eight previous studies of the timing ability in mutual fund managers, stock traders, option traders, and individual investors across several U.S. and international indexes. The MTBH metric is particularly accurate in explaining the positive timing results for options traders and hedge fund managers, but not as accurate in explaining mutual fund timing. The MTBH metric provides an alternative explanation for non-persistent market-timing results outside of the investors’ behavior or skill and can be applied to any foreign or domestic market to evaluate managers’ timing results.

Does Modern Portfolio Theory Need an Update? Analyzing Single-Country ETFs During Extreme Market Movements

This article investigates whether country characteristics can determine diversification benefits provided by single-country exchange traded funds (ETFs) to U.S.-based investors during crises and non-crises periods. We find several country-specific characteristics, including prior correlation, foreign direct investment, GDP growth rate, inflation rate, and inclusion in the G7 are significant in explaining diversification benefits during non-crises periods. We find that most of the coefficients lose significance during the crises periods in both raw and contagion corrected models, proving the choice of which international funds to invest is difficult for investors in today’s global financial marketplace. This study finds that investors seeking protection from extreme U.S. market returns are not able to identify which single-country ETFs will serve to diversify their portfolios during extreme market movements using easily accessible finance and economic variables. The results of this study further complicate the decisions investor face in creating a well-diversified portfolio and serve as a warning to individual investors and managers attempting to determine which country single-country ETFs will provide diversification benefits using traditional estimation tools.

When to Time in the Stock Market: An International Examination of Factors that Influence Market Timing

The objective of this study is to determine if readily available finance and macro-economic variables can explain which years have favored market timing strategies versus which years favored buy and hold investing, in order to help traders determine when to allocate funds from passive to active investment strategies. We find that when real GDP growth rates, inflation rates, and PE ratios were low or negative, and when dividend yields were high, market timing strategies were favorable across 44 country market indexes from 1995–2008. These results are robust to country level of development, negative market return years, and other control variables. The conditions for pursuing market timing strategies were time-variant and detectable with macro-economic and finance variables. We introduce and test a new metric, Market Timing–Buy and Hold (MTBH), which measures the conditions of pursuing market timing strategies relative to buy and hold investing. The MTBH metric is an ex post measure that allows one to examine when it has been advantageous to switch from buy and hold investing to a market timing strategy using macro-economic and financial variables.

Quest for Diversification: Should U.S. Investors Venture into European ETFs?

The recent explosion of country- and region-specific exchange-traded funds (ETFs) has given rise to some basic questions on how to select the right ETF for a specific purpose. ETFs gained tremendous popularity with individual investors and money managers due to their ability to provide investors with diversification at a very low cost of ownership. But just as mutual funds reached a saturation point, have ETFs also reached this point where few, if any, additional ETFs are providing diversification benefits? The question to be answered in the study is whether European ETFs with higher diversification benefits require a cost of ownership premium relative to other ETFs. Using a sample of European country-specific ETFs and continental Europe ETFs, the author finds that ETFs with high expense ratios and high turnover provided a positive and significant diversification benefit to investors. European ETFs with higher fees and turnover experienced lower levels of return correlation with the SPY over the last five years. Unfortunately, those higher expense ratios and turnover levels were not significant in explaining ETF performance, leaving investors with the difficult question, Where do European ETFs fit for an investor seeking diversification?

When to Gamble in the Stock Market

The objective of this study is to determine if readily available finance and macro-economic variables can help investors determine which years are more favorable to pursue market timing strategies and which years favor buy and hold investing. When real GDP growth rates, inflation rates and PE ratios were low or negative and when dividend yields were high, market timing strategies were favorable across 44 country market indexes from 1994-2008. These results were robust to country level of development, negative market return years and other control variables. The conditions for pursing market timing strategies were time variant and detectable with macro-economic and finance variables. A metric (Market Timing – Buy and Hold) was tested which measures the conditions of pursuing market timing strategies relative to buy and hold investing. The MT-BH metric allows investors and brokers to determine when to switch from buy and hold investing to a market timing strategy using macro-economic and financial variables and helps to explain why market timing skill of managers is rarely found to be persistent.

Blackjack and the Market Timing Puzzle

The objective of this paper is to establish that variation in market timing results can be attributed to the favorability of engaging in market timing strategies and not changes in investors behavior or skill. This hypothesis is very similar to the idea successfully tested in playing 21 by Thorpe in “Beat the Dealer” (1966). Just as the conditions of playing the game of blackjack switch from favoring the house to favoring the player, I propose that the conditions of the market can switch from favoring buy and hold investing to favoring market timing strategies and these conditions can be systematically measured in any equity market. The MT-BH metric measures the favorability of engaging in market timing strategies in any equity trading market. The MT-BH metric was created for 44 country indexes from 1994-2008 to indicate which years were most favorable for market timing strategies. This study generalizes the market timing results of eight past studies covering mutual funds, stocks, option traders and individual investors across several US and International indexes. The MT-BH metric is particularly accurate in explaining the results for option traders and hedge fund managers. Academics and practitioners now have an additional metric from which to measure market timing skill of an investor or manager across any equity market.

Did Margin Rules and Financial Development Affect Returns and Volatility - During the Market Crash of 2007-2008?

This article aims to determine if the type of margin rules on an exchange or financial development contributed to or dampened the stock market returns or volatility of returns during the worldwide market sell-off from October 16, 2007 to October 22, 2008. The author finds that rigid margin rules significantly reduced the weekly index return volatility during the crash period and also reduced the change in weekly index return volatility compared to the past 5 years. There is no evidence that margin rules had any impact on returns during the crash period, refuting the pyramiding hypothesis. Return volatility was positively related to financial development during the crash period but negatively related to volatility before the crash period, suggesting that the cause of the crash centered in the financially developed world. Regulators from around the world would be interested in how margin rules on different exchanges can increase or dampen returns or volatility during extreme market movements and how financial development interacts with return volatility during extreme market conditions.

International Economic Freedoms, Banks and Contagion During the Market Crisis of 2007-2009

The objective of this paper is to test if banks in highly regulated countries performed better than banks in less regulated countries during the market crisis of 2007-2009. An additional test is if the magnitude of contagion was greater between the banking indexes relative to the overall market indexes during the crisis period, confirming contagion between the banking sectors around the world. Bank index returns from 46 countries were examined from October 1st 2007 to March 3rd 2009 and revealed that high levels of financial freedoms, measured by the Heritage Foundation Freedom Rankings, resulted in higher banking index returns. The results indicate that less government involvement in an economy was positive for banking index returns during the crisis period. Market index returns experienced a much greater degree of correlation compared to banking indexes, indicating banks did not experience contagion to the same degree as the overall market indexes during the crisis. Therefore, the financial crisis of 2007-2009 cannot be solely blamed on the banking sector and the crisis should not serve as the justification for additional regulations and government involvement in the economy.