Long-Term Investors and Valuation-Based Asset Allocation
20 Pages Posted: 4 Jan 2015
Date Written: November 1, 2011
Valuation-based market timing demonstrates strong potential to improve risk-adjusted returns for conservative long-term investors. Such timing strategies based on the cyclically-adjusted price-earnings ratio provide comparable returns as a 100 percent stocks buy-and-hold strategy but with substantially less risk. Meanwhile, market timing provides comparable risks and the same average asset allocation as a 50/50 fixed allocation strategy, but with much higher returns. Also, it is important to consider less extreme timing strategies as well, as defining market timing as either all stocks or all cash does not provide a hedge against the possibility that valuations may depart from their historical averages for extended periods. Finally, comparing the strategies over shorter rolling sub-periods reveals that a valuation-based market timing approach fairly consistently provides risk-adjusted returns superior to a fixed asset allocation strategy.
Keywords: market valuations, cyclically-adjusted price-earnings ratio, PE10, stock returns, market timing, long term, tactical asset allocation, buy and hold
JEL Classification: C15, D14, G11, G14, G17, N21, N22
Suggested Citation: Suggested Citation