Archive for December, 2011

Market Timing

Monday, December 26th, 2011

Can amateurs time the market? Some simple, non-proprietary indicators that make sense:

The 200-day moving average profits from trends. In this system, the market is trending upward when it crosses its moving average (buy), and falling when it corsses below (sell). The system fails in cyclical markets, i.e where mean-reversion profits. (See Faber and Hulbert)

The multi-year (5 to 10 years) PE ratio is cyclical. It’s a bet on mean-reversion. Logically, it’s a good complement to a trend-following system such as a moving average. (See Hussman and CXO Advisory)

A normal yield curve, in which 10-year Treasuries are more than 65 basis-points higher than 90-day Treasuries is strongly correlated with bull markets. (See Crossing Wall ST and a more recent look). However, the yield curve right now is considered by some to be abnormal, because the government is keeping short-term rates at near 0%. See this interview with bond-expert Van Hoisington for example.

What would happen if you just invested in thirds? Put 1/3 of your portfolio into the market when it’s above the 200-day moving average (thus capturing the profit available due to trending). Invest another third when the market’s long-term PE ratio is at or below average (capturing the profit predictable from mean-reversion). And add the final third based on the yield curve.

Another overall valuation metric is the ratio of total stock market capitalization to GNP or GDP. This could supplement the 10-year PE ratio, or you could break the portfolio into fourths, giving it more of a value-tilt. (See Warren Buffet and Motley Fool)

Where to find the data:

  • Buffet’s ratio. GDP-version: (it predicts the market is at the high-end of fairly valued, with a likely annual return of 5.1%).
  • A 10-year PE ratio: Schiller and (currently high, predicting a low return).
  • 200-day moving average for VTI (a total stock market ETF): Yahoo! Finance (currently the market = its moving average).
  • The yield curve: US Treasury …use the 3-month and 10-year columns (currently very bullish, but note concerns about atificially low interest rates right now).

* Day-late update: There is also Tobin’s Q, which is similar to book value. See Smithers, which also mentioned Schiller’s 10-year PE ratio (called “CAPE” for “cyclically adjusted”), and Equities and Tobin’s Q. Tobin’s Q also suggests the market is slightly overvalued.
* Another source of info on Buffet’s and Schiller’s market valuation methods is MyPlanIQ.

Another good article on the current stance of the yield curve: