Formula for Imagination
This issue of the Journal of Financial Planning includes the article “Tactical Think Tank: A Fundamental Answer for Tactical Asset Allocation” by Brent R. Brodeski, Gina M. Beall, and Adam W. Larson. The authors describe their participation in the Tactical Think Tank (TTT). Consider this excerpt: “… we were intrigued by the idea of 10 leading RIA firms putting their heads and resources together to research one big investment question—is it possible to predict the market and benefit from tactical asset allocation? In other words, is there a crystal ball or silver bullet solution for market timing? If so, could we improve our investment process to predict things like the global financial crisis of 2008–09?”
No spoiler alert is needed to tell you that think tank participants discovered no crystal ball or silver bullet. Instead, they came away with renewed confidence that it’s impossible to predict the short-term market. But the exercise yielded unexpected benefits. As the authors put it, “Our participation in TTT led to our development of a decision framework for evaluating different investment strategies and ultimately led us to improve our methodology for calculating long-term expected returns.”
The notion of assembling a high-powered team to explore the possibility of market timing reads like the prologue to a Jules Verne novel or Indiana Jones adventure. Market timing may forever remain an illusion—even a dangerous one—but there’s no denying its relentless hold on our imagination. It’s the investing world’s Holy Grail or Fountain of Youth. And like those myths, it’s found its way into pop culture.
Writer-director Darren Aronofsky’s breakthrough film Pi told the story of a researcher obsessed with discovering a mathematical formula to unlock the secret of predicting stock performance. (Interestingly, Aronofsky went on to film his own exploration of the Fountain of Youth, simply called The Fountain.)
In December 2009, the Journal published an award-winning concept paper by Paul D. Tomasula Jr., who echoed fractal geometry “inventor” Benoît Mandelbrot’s research. Tomasula observed that financial planning software usually groups the probabilities of market moves under a Gaussian distribution. This bell-shaped curve makes outlying results seem random, which frustrates portfolio owners’ expectations. Using an alternate distribution model, market moves appeared to be more consistently organized and yielded valuable information for constructing portfolios.
In our December 2011 issue, Kenneth R. Solow, Michael E. Kitces, and Sauro Locatelli proposed a tactical asset allocation strategy designed to opportunistically take advantage of extreme valuations. The idea constituted market timing “only in the best sense” they said, adding, “Such modest market-timing shifts in this context allow investors to obtain higher returns with lower risk than a buy-and-hold portfolio strategy.” Wade Pfau’s April 2012 paper on valuation was also about “timing” in a similar vein.
A prudent financial planner won’t focus on market timing in a discussion with investment clients. But fascination with the topic continues to yield some interesting explorations. It’s okay to dream about silver bullets, especially if your dreamscape expands the horizons of your practical world.