Subject: Re: Beating the market
My theory is based on the idea, that the more you buy when it looks like the world is going to end, the more you can make. At the same time, you have to sleep at night.

This goal of changing your stock and bond allocation to outperform the market is exceedingly more difficulty to do that it sounds, even if following a routine 100% reliably.

Aiming for lower but smoother returns is easily achieved just by fixing the bond allocation by whatever percent you want to smooth the returns. But the long term CAGR will be close to guaranteed to be below the equities market.

Relying on recent market performance (as you wished, to wait for the market to fall and then increasing your allocation to stocks - timing the market by means of assuming better forward returns follow after recent negative returns) doesn't work as well as it sounds. If you backtest forward returns based on recent past returns being negative, you don't get an advantage. In fact, for the best one year return you are best off buying more when the last year has had strong, not weak, performance, owing to market momentum. As a rule of thumb a price change look back over X years is statistically mildly predictive of forward X year returns especially for X in any range from one minute to one year.

To allocate between stocks and bonds, I would strongly avoid using negative recent price performance as your indicator for a higher stock allocation, unless you have some new evidence of this working in some nuanced context.

Instead, aim for an indicator that relates not to the price. For example, the CAPE ratio (PE10) or a market sentiment indicator.

Remember, and this point is very central: In order to have the capacity to add capital during a pessimistic market mood you need to have less than 100% exposure at all times when the mood is not pessimistic. You of course need to get the cash from somewhere when allocating more at your lower quotes. You of course need to get the cash from somewhere when allocating more at your lower quotes. The gains you make on adding capital at pessimistic periods has to counteract far larger effect of having a reduce exposure for the bulk of your holding period. To put this another way, even if you beat the market with your low entry points (timing is successful) then this is not a sufficient condition to beat the market as a whole with your entire portfolio. You have to not only have market beating returns for the extra stock purchases at market lows, but that outperformance needs to exceed the underperformance from the huge drag owing to the reduced equity exposure over most of the portfolio's life.

Having a way to allocate between stocks and bonds, with excess stock exposure (over-allocation as you put it) when forward expectations are higher, is a huge area of research. Many investors, arguably the majority, have tried it or are trying it. I have yet to find anyone who can do it in such a way to beat the market. This is quite incredible because it intuitively it seems that it should be straight forward.

Elan's publishing of the Arezi ratio is a quintessential example of using indicators to determine the stock and bond exposure. I would research the efficacy of those indicators amongst your research.

I have not found something that works better than 100% stock exposure at all times but I admire anyone backtesting various indicators to change the bond allocation to produce a market beating strategy.

I have always been attracted to the idea of using an indicator based on the mood news stories but I have not found a method that works across time reliably, particular as the way language is used changes very much over time.

- Manlobbi