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Market-Timing Strategies That Worked

FRB of Kansas City Research Working Paper No. 02-01

39 Pages Posted: 20 Oct 2003  

Pu Shen

Federal Reserve Bank of Kansas City - Economic Research Department

Date Written: May 2002

Abstract

In this paper, we present a few simple market-timing strategies that appear to outperform the "buy-and-hold" strategy, with real-time data from 1970 to 2000. Our focus is on spreads between the E/P ratio of the S&P 500 index and interest rates. Extremely low spreads, as compared to their historical ranges, appear to predict higher frequencies of subsequent market downturns in monthly data. We construct "horse races" between switching strategies based on extremely low spreads and the market index. Switching strategies call for investing in the stock market index unless spreads are lower than predefined thresholds. We find that switching strategies outperformed the market index in the sense that they provide higher mean returns and lower variances. In particular, the strategy based on the spread between the E/P ratio and a short-term interest rate comfortably and robustly beat the market index even when transaction costs are incorporated.

Keywords: Investment, Stock Market, Earning Yields

JEL Classification: G10, G11, G14

Suggested Citation

Shen, Pu, Market-Timing Strategies That Worked (May 2002). FRB of Kansas City Research Working Paper No. 02-01. Available at SSRN: https://ssrn.com/abstract=445920 or http://dx.doi.org/10.2139/ssrn.445920

Pu Shen (Contact Author)

Federal Reserve Bank of Kansas City - Economic Research Department ( email )

1 Memorial Dr.
Kansas City, MO 64198
United States
816-881-2543 (Phone)
816-881-2199 (Fax)

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