Market Timing Strategies That Worked

Abstract

1. Pu Shen 1. A senior economist in the research division of the Federal Reserve Bank of Kansas City (MO 64198). (pu.shen{at}kc.frb.org) There is evidence that a few simple market timing strategies appear to have outperformed a buy-and-hold strategy in the 1970–2000 period. The example here is based on spreads between the E/P ratio of the S&P 500 index and interest rates. Extremely narrow spreads compared to historical ranges appear to predict more frequent market downturns to come. A switching strategy based on extremely narrow spreads and the market index calls for investing in the stock market index unless spreads are narrower than some predefined threshold. Switching strategies like this outperformed the market index in terms of higher mean returns and lower variances. A strategy based on the spread between the E/P ratio and a short-term interest rate comfortably beat the market index in this period, even considering transaction costs.

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