Can money managers beat the market through market timing? Even people who think that it is possible to beat the market through stock selection seem to think that successful market timing is impossible. The belief in the futility of market timing appears to be rooted in Sharpe’s argument that the advantage of a buy-and-hold portfolio is so large that it would take truly superior predictive ability to beat it. But is the advantage of the buy-and-hold strategy really so enormous?

A market timer who follows optimal rules can expect higher returns and lower risk than a buy-and-hold stock investor. Furthermore, the returns on the market timer’s portfolio increase as the level of his information increases. Even modest amounts of information can bring substantial advantage. A model that predicts monthly stock returns with an R-squared of 0.09, for example, can be expected to give a market timer a 5.9 per cent annual return advantage over a buy-and-hold investor.