Market timing on the Johannesburg Stock Exchange under different market conditions

Master Thesis

2002

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University of Cape Town

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The objective of this study is to evaluate the performance and risk characteristics of three market timing strategies, namely traditional, bull and bear timing, and how different market conditions affect these strategies. The market is segmented into bullish and bearish phases and three independent but corroborative studies test how each of the timing strategies perform under the identified market conditions by measuring the returns, the required predictive accuracy and the degree of risk taken. The results of the various studies are compared across the three timing strategies as well as across the different market conditions. This gives an indication of each strategy's performance and risk characteristics. The results of the three studies indicate that potential rewards from market timing are high if perfect forecasting is achieved. This return will also be achieved at a lower level of risk compared to that of the market. However as the forecasting ability falls the advantages of market timing are quickly eroded. The potential returns are not only lower but will generally be achieved at a higher level of risk compared to perfect timing, unless a bull timing strategy is employed. To be guaranteed success at market timing, predictive ability of approximately 80% is required. For timing abilities below this threshold the success and risk profile of such a strategy will largely be dependent on which review periods are incorrectly predicted. For predictive ability below about 60% investors are more likely to under perform the market than to beat it. On a risk adjusted basis this falls to 55% suggesting that investors need at least some level of predictive ability to be successful at market timing. The results also suggest that it is generally more important to predict the bullish periods than the bearish ones. It is also evident that the market condition has a significant effect on all the market timing strategies analysed. When the market is in a bullish phase, extremely high levels of predictive accuracy are required just to have an even chance of beating the index, even to the extent that a bull timing strategy may not outperform the index regardless of the predictive ability. Only on a risk adjusted basis are returns above the market possible, albeit at high levels of predictive accuracy. Evidently, when the market is bullish, market timing is not a viable investment strategy. Nevertheless this study does highlight that there exists pockets of time where market timing may be viable. When the market turns bearish the required forecasting ability necessary to outperform the market falls drastically such that random guesses as to the next review period's performance are more than likely to produce a return above that of the market. Again, market timing during a bearish period achieves returns at a level of risk below that of the index. The studies also give insight as to how each of the strategies themselves perform under the different market conditions. It is clear that, for very high levels of predictive accuracy, traditional timing performs the best on both a nominal and on a risk adjusted basis. However, poor timing using this strategy performs the worst on a nominal basis. Only when risk is taken into account does poor traditional timing outperform poor bull timing.
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Bibliography: leaves 94-96.

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