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Stock Market Timing Using P/E SMA Signals

Posted in Equity Premium, Fundamental Valuation

A subscriber proposed four alternative ways of timing the U.S. stock market based on simple moving averages (SMA) of the market price-earnings ratio (P/E), as follows:

  1. 5-Year Binary - hold stocks (cash) when P/E is below (above) its 5-year SMA.
  2. 10-Year Binary - hold stocks (cash) when P/E is below (above) its 10-year SMA.
  3. 15-Year Binary - hold stocks (cash) when P/E is below (above) its 15-year SMA.
  4. 5-Year Scaled - hold 100% stocks (cash) when P/E is five or more units below (above) its 5-year SMA. Between these levels, scale allocations linearly.

To obtain a sample long enough for testing these rules, we use the monthly U.S. data of Robert Shiller. While offering a very long history, this source has the disadvantage of blurring monthly data as averages of daily values. How well do these alternative timing strategies work for this dataset? Using monthly data for the S&P Composite Index, annual dividends, annual P/E and 10-year government bond yield since January 1871 and monthly 3-month U.S. Treasury bill (T-bill) yield as return on cash since January 1934, all through August 2018, we find that:

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