Where Do Stocks Go From Here?

YOU DON'T NEED ME to tell you, but it was an awful June, quarter, and first half of the year.

The 10.2% loss turned in by the Dow Jones Industrial Average during June was the third worst for that month in this index's history, eclipsed only by 1930 and 1896.

The Dow's loss during the second quarter is not ranked quite as close to the bottom as June's, but still low: Only 15 other years out of the last 112 have had second quarters with worse returns.

So where do we go from here? Is the stock market destined for much bigger losses, now that some of the major market averages are in official bear market territory?

For insight, I decided to turn to the top-performing stock-market-timing newsletters. I defined this group to be the 10 services with the best risk-adjusted market-timing returns over the last 15 years, according to the Hulbert Financial Digest.

As I often advise my subscribers to do when they engage in such an exercise themselves, it's important to define the group of top performers by focusing on performance over a long enough period to include both a bull and a bear market. That way you eliminate newsletters that are either bullish or bearish stopped clocks.

For example, we would not satisfy this requirement if we were to focus on market-timing performance over just the last 10 years. As measured by the Dow Jones Wilshire 5000 total-return index, the market has gained just 3.6% annualized over the last 10 years, far lower than the long-term average. Focusing on top timers over this 10-year period therefore runs the risk of having a bearish stopped clock appear at the top of the rankings.

That's why for this column I chose to focus on 15-year performance. Over that longer period, the Dow Jones Wilshire 5000 index produced a 9.3% annualized return, which is within shouting distance of the stock market's historical average.

I eliminated one of the 10 top performers because it is a purely mechanical model based on the calendar. Its good performance notwithstanding, its current posture tells us little about the market's prospects.

That leaves nine newsletters in this group of top timers. What follows is a brief synopsis of what each of them is currently saying about the stock market. (The newsletters are listed alphabetically.)

• Blue Chip Investor: Bullish. Editor Steven Check's valuation model, based on a comparison of the earnings yield of the stock market and the yield on corporate bonds, shows stocks currently to be in the "Very Undervalued." In his July issue, Check cautioned subscribers against giving too much credence to those who, in effect, say "this time is different." "Of course every decline has its own set of problems and concerns," Check writes. "Think back, however: We had strikingly similar problems in 1990. That was just before the first Iraq war. Oil prices were rising. The savings-and-loan crisis was in full swing and the real-estate market was struggling. The economy was officially in a recession, and the market fell 20% from July 16 to October 11. What happened next? Stocks gained 30% in 1991." Check's model portfolio is close to being fully invested in stocks.

• Bob Brinker's Marketimer: Bullish. In his most recent issue, which was published in early July, Editor Bob Brinker reported that his stock-market timing model remains in favorable territory. However, he cautioned that oil's price constitutes a "wild card." "In the event oil prices continue to rise, consumers and the stock market will be held hostage to the cost of energy. This would provide a strong headwind against the economic recovery process. If oil prices stabilize or decline from current levels, we believe stock prices can make progress into 2009." Brinker is recommending that subscribers' stock portfolios be fully invested.

• Chartist. Bearish. Editor Dan Sullivan turned bearish on the stock market in mid-January. Earlier this week, Sullivan wrote to his subscribers: "The economic news continues to paint a bleak picture with unemployment creeping higher, the housing market still weakening and inflation around the globe skyrocketing… [A] positive note is that when things look the bleakest the future returns are the brightest. At some point we are going to have another excellent buying opportunity. But for now we continue to recommend 100% money market funds."

• Growth Fund Guide. Bearish. Editor Walter Rouleau believes that the investment markets over the next several years will be dominated by a trend away from financial assets such as stocks and toward inflation hedges such as gold and other hard assets. "While we, nor anyone else, can tell you exactly where the gold market or the S&P 500 are in their super bull and super bear markets, our analysis suggests these trends could last for years. One possible target date we have repeated several times…is 2012 for a low in the S&P 500." Rouleau's model portfolios currently have an average equity allocation that is 14% short.

• Investor's Guide to Closed-End Funds: Bullish. Editor Thomas Herzfeld's "U.S. Equity Funds" model portfolio is around 92% invested.

• No-Load Fund Investor: Neutral to moderately bullish. Editor Mark Salzinger's so-called "Wealth Builder" portfolio, his letter's most aggressive, currently allocates 70% to U.S. equities and another 15% to international stocks.

• Timer Digest: Neutral to moderately bearish. Editor Jim Schmidt bases this newsletter's market-timing model on a consensus of the top market timers. His consensus of the top 10 based on performance over the last 52 weeks is neutral, with four bulls, four bears, and two neutral. His consensus of the top 10 for performance over the last two years is bearish, with two bulls, seven bears, and one neutral. The newsletter's model portfolios currently are about 64% invested in stocks, on average.

• Vantage Point: Bearish. Editor John Harris writes that "Until the price of energy levels off, inflation will be a threat and the Fed will have some tough monetary policy challenges to weigh. The long-term moving averages, which define the long-term trend, are bearish for the major averages. Risk levels are such that a defensive 50% to 67% cash."

• Vickers Weekly Insider Report. Bullish. The ratio of insider sales to insider purchases remains well below historical norms, which is a bullish omen, according to this newsletter. The services' two model portfolio are, on average, about 87% invested in U.S. stocks.


The picture is mixed, to be sure. Just four of these nine top timers are bullish, while four more are bearish and the ninth classified as neutral to moderately bullish. The average equity allocation among all nine is 60%.

The moral of the story, if it were to end here, it would be to be only moderately bullish at best.

But the story doesn't end here. Contrast the 60% average recommended equity allocation among the top timers with the comparable average among the 10 market-timing newsletters with the very worst records over the last 15 years. Those worst timers currently are 2% short the market, on average, or 62 percentage points less than the average of the top timers.

That is a bullish contrast. It means that to bet that the stock market will decline from here, you have to bet that the timers with the worst records over the last 15 years will be more right than those with the best records.

Anything can happen, of course. And, indeed, throughout the decline that began last fall, the best performers have been more bullish than their poorer-performing brethren. So, at least in recent months, the profitable bet has been the one that has gone against the top performers.

Still, successful investing requires a disciplined paying attention to the odds. And the odds favor the past's winners when, as I have in this column, measured performance over a long-enough period that winning and losing is unlikely to have been caused by mere luck alone.

The bottom line? The average top-performing market-timing letter has pulled a few chips off the table. But he remains far more bullish than the timers with the worst records.