Blog Archives

Estimating Forward 10-Year Stock Market Returns using the Shiller CAPE Ratio and its 35-Year Moving Average. (Update Dec-2018)

  • The Dec-2018 Shiller Cyclically Adjusted Price to Earnings Ratio (CAPE-ratio) stands at 27.9, which is 11.0 above its long-term mean of 16.9, signifying overvaluation of stocks and low forward returns.
  • The MA35-CAPE-Ratio methodology references stock market valuation to a 35-year moving-average of the Shiller CAPE-ratio (MA35) instead of the 1881-2018 long-term mean which the standard forecasting method is based on.
  • The MA35-CAPE-Ratio method should be superior to the standard CAPE-ratio method as only the percentage difference between the CAPE-ratio and its MA35 is considered, and not the absolute difference.
  • The MA35-CAPE-Ratio method and the falling trend of the CAPE-ratio currently signal a forward 10-year annualized real return for stocks of about 5.8%, while the historic long-term trend forecasts 5.0%.
  • Only the ratio between the prevailing CAPE-ratio and its 35-year moving average (CAPE-ratio / MA35) is needed to easily obtain the expected 10-year forward returns from the charts in this article.

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The iM-SuperTimer: Timing the Market with the iM-Stock Market Confidence Level

  • The system uses a composite model consisting of several market timers. It should deliver more reliable signals for profitable stock market investment than single market timing models.
  • Component timers are allocated a 100% stock holding percentage when the timer signals investment in the stock market, or 0% when the timer it is out of the stock market.
  • A weekly Stock Market Confidence Level (SMC level), which can range from 0% to 100%, is obtained by considering the percentage allocated to each component timer and the timer’s weight in the system.
  • The optimal SMC level for stock market investment is found by optimizing a stock-bond model for various SMC levels considering returns and drawdowns relative to buy-and-hold the S&P 500 index.
  • A backtest of a combination model of thirteen iMarketSignals timers signaled avoidance of the stock market for SMC levels <=50%, while SMC levels >50% suggest better stock market investment climates.

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The iM-FlipSaver Models (Revised)

In order to simplify retirement investment we are replacing our iM-Vanguard/TIAA-CREF Systems (updated monthly) with three iM-FlipSaver Models (updated weekly).

Prudent investors have assets allocated to both bonds and stocks. This conservative strategy is found in the Vanguard LifeStrategy Funds that invest statically in bonds and stocks and also in Life-Cycle/Target-Date Retirement Funds.

Instead of a static bond/stock ratio, these models change allocation in accordance with stock market conditions; e.g. during up-market periods the models hold more stocks than bonds, and during down-market periods the allocation “flips” to holding less stocks than bonds. This should improve performance and reduce drawdowns.

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The iM-Low Frequency Timer

  • Over the last 20 years this Timer provided only two exit periods for the stock market.
  • By being out of the stock market during those periods one would have avoided most of the two bear markets and losses of 35% and 43%, respectively.

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Timing the Market with Google Trends Search Volume Data

  • Past research suggests that the relative change in the volume of Google searches for financial terms such as “debt” or “stocks” can be used to anticipate stock market trends.
  • In this analysis the search term “debt” was used to obtain monthly search volume data from Google Trends.
  • The analysis shows, that a decrease in search volume typically preceded price increases of the S&P 500 index, and vice versa.
  • Switching between ETF (SPY) and ETF (IEF) based on monthly search volume data from 2005 to 2018, would have made a profit of 634% versus 220% for buy-and-hold SPY.

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Out-Performing the US Market With the iM-Country Rotation System

  • The iM-Country Rotation System periodically selects one country ETF from six countries, USA, Canada, Japan, Australia, Germany and Sweden, based on the performance of their respective currency ETFs.
  • Backtests from 2009 to 2018 (the bull market period) show that each foreign country ETF under-performed the US stock market over the full backtest period.
  • However, when periodically selecting ETFs using a ranking system based on the performance of the countries’ respective currency ETFs, the model significantly out-performed the US stock market.
  • Over the period 3/9/2009-7/21/2018 the system showed a simulated annualized return of 29.4% versus 18.7% for the SPDR S&P 500 ETF Trust (SPY), with similar maximum draw-downs of about -19%.

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Better Returns From Seasonal Investing In The S&P 500 (1950-2018)

  • From 1950 to 2018 the S&P 500 performed best from November to April, and significantly worse from May to October during most years.
  • From 1950-2018 the real annualized return for the S&P 500 was 6.71%. Had one only invested from November to April each year the return would have been 6.60%, almost the same.
  • Investing in a money-market fund from May to October each year and the remaining time in the S&P 500 would have provided a higher real annualized return of 7.17%.
  • For the 32 year period of rising interest rates (1950-1982) the real return of the S&P 500 was only 5.40%, much less than for following 36 years of falling interest rates.

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The iM Seasonal ETF Switching Strategy

  • This strategy exploits the anomaly that Cyclical Sectors and Small Caps perform best from November to April, and Defensive Sectors do better from May to October during most years.
  • In this analysis only one ETF is periodically selected by a simple ranking system from the cyclical and defensive groups, respectively, and held for six months.
  • Out of the 37 six-month periods, 36 periods showed gains ranging from 0.1% to 28.1%, while only one six-month period produced a loss of -9.3%.
  • For the approximately 18.5 year period from end of Oct-1999 to May-2018 the backtest showed an annualized return of 19.8% with a maximum drawdown of -30%.
  • For an “inverted” switching strategy, when cyclicals ETFs are used for the May-October period and defensive ETFs during November-April period, the annualized return was 3.2% and maximum drawdown was -60%.

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Deja Vu 2007 — Is the Stock Market Overvalued? Estimating Returns to 2020 and Beyond, Update Jan-2018

  • Based on its historic trend, the stock market appears to be overvalued.
  • The Shiller Cyclically Adjusted Price to Earnings Ratio P/E10 is at high level of 33.5 (and P/E5 of 28.0), and a market correction is possible.
  • Similar conditions for the P/E5, and S&P-real’s position relative to the long-time trend, were observed only 3-times in the past: in 1937, 1998 and 2006.
  • The historic trend suggests a total probable real loss of about 15% over the next two years.
  • Analysts’ long-term forecasts of stock returns made 7 years ago appear to have been unrealistically low.

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How to Avoid the Coming Bear Market Indicated by Shiller’s CAPE Ratio: Update December 2017

  • The Cyclically Adjusted Price to Earnings Ratio (CAPE ratio) is at 32.1, a very high level which signals overvaluation of stocks and low forward returns, according to Shiller.
  • This level was only exceeded twice in the last 136 years, in Sep-1929 and from Jul-1997 to Jul-2001, with market declines of 77% and 45% then recorded.
  • The Moving Average CAPE Ratio Methodology used here references stock market valuation to a 35-year moving average of the Shiller CAPE ratio instead of the 1881-2017 long-term average.
  • Based on the 35-year moving average methodology, historic market performance points towards continuing up-market conditions, possibly for a number of years.
  • To avoid the bear market, exit stocks when the spread between the 5-month and 25-month moving averages of S&P-real becomes negative and simultaneously the CAPE-Cycle-ID score is 0 or -2.

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