“Even the best market timers correctly forecast short-term advances and corrections only two out of three times.”

“Astute investors allocate out of a sector on an extreme advance and allocate into a sector after an extreme correction.”

“In a strong bull market like this one, the odds are that you will miss the next leg up instead of avoiding a brief downturn when you try to time the market.”

I consistently recommend that investors make their key asset allocation decisions based on highly predictable long-term economic trends. Such long-term forecasting is what I call “deterministic” because it reflects simple cause-and-effect changes over time. Short-term forecasting, which is based on many random factors that are overwhelming in their complexity, is “probabilistic” in nature. The odds of being right in a random situation are the same as the odds of correctly guessing whether a coin will come up heads or tails.

Guessing what the markets will do in the short term is also a 50-50 bet at best. When you factor in the effect of fear and greed, the emotions that typically guide our investment decisions, the odds often fall well below 50-50.

Few investors, however, are immune to short-term changes in the market. In fact, the prominence of day traders in the media has changed the meaning of “short-term” from a few weeks or months to a single 24-hour day. One outcome of this is that it is even more difficult to sustain a systematic investment strategy based on a long-term view of the economy, which is the forecasting method I have advocated for years. Many investors feel compelled to make immediate investment decisions. We react emotionally more than we respond objectively one of the best reasons to work with a competent financial advisor.

The unpredictability of short-term economic trends does not mean we can’t leverage corrections in the stock market. We may not be able to predict strong corrections or advances reliably, but we know when they have occurred. The key point is that short-term changes in the market affect different sectors to different degrees.

The premise of dynamic portfolio rebalancing is simple: When a correction hits a sector that is fundamentally strong in the long term, don’t panic and jump out! Consider it a buying opportunity and invest more of your assets in that sector. Similarly, watch any strong advances that favors a certain sector with an eye towards selling high. The laws of probability dictate that such a sector is likely to get hit harder in the next correction.

For example, suppose in the last decade you were invested in an aggressive growth portfolio that allocated 32.5% to technology, 32.5% to financial services, 15% to health care and 20% to Asia (excluding Japan). When Asia dropped by more than 60% in late 1997, it was the perfect time to buy more Asian equities, not sell, because long-term trends indicate that Asia was then and would continue to be a good investment. As we saw, the Asian sector of the aggressive growth portfolio had the strongest rebound after the worldwide correction through late 1999.

Here’s another example of dynamic rebalancing. In the correction from mid-July into early October of 1998, the leading financial services stocks were down more than 60%. Time to sell? Not at all. It was another buying opportunity, since long-term forecasting indicated that financial services would continue to be one of the fastest growing sectors in the market. As we saw between late 1998 and early 2000, financial equities rebounded dramatically.

Here’s another example. From late 1998 into early 2000 the technology stocks had outstripped every other strong sector by a wide margin. Buy more? No, it was time to sell a portion and either hold cash and wait for a good buying opportunity which occurred when the NASDAQ corrected or redistribute your assets into other fundamentally sound sectors like health care or multinational stocks that had underperformed

To summarize, it isn’t necessary to jump out of the market every time some expert thinks there’s going to be a correction or to jump in when that same expert says the market has reached a low. But by paying attention to short-term changes in a fundamentally sound sector, you’ll find opportunities to buy low and sell high, substantially increasing your returns and lowering your risk.