Market Timing with Multiples, Momentum & Volatility

Getting Comfortable with High Equity Multiples

June 2018. Reading Time: 10 Minutes. Author: Nicolas Rabener.


  • Equity multiples have been elevated in recent years
  • Using valuation multiples for allocation decisions is a challenging strategy
  • Momentum and volatility-based strategies are more attractive


In recent years the stock market in the US has been expensive on a variety of valuation multiples, which is often cited for why investing has become more difficult. However, in 2009 valuation multiples were much lower, but investing was not regarded as particular easy as most market participants were concerned about a second Great Depression. A rational observer might conclude that investing is challenging regardless if stocks are expensive or cheap. The same observer might question if valuations are meaningful for future stock returns and can be used to make investing less difficult. In this short research note we will evaluate using valuation multiples for market timing and also assess alternative methods (read Market Timing vs Risk Management).


We focus on the US stock market, where price and valuation multiple data is available from 1881 to 2016 from Robert Shiller. The analysis utilises the cyclically adjusted price earnings ratio (“CAPE”), which uses real earnings per share over a 10-year period to smooth out fluctuations in corporate profits that occur over a normal business cycle. The results do not include transaction costs, but turnover is infrequent and therefore costs are not significant.


Academic research has shown that buying cheap and selling expensive stocks generates excess returns across time and markets, which is typically referred to as the cross-sectional long-short value factor. The same concept can be applied to stock markets from a time series perspective, i.e. invest in the market when valuations are low and do not invest when valuations are high. The chart below shows the 10-year forward returns per annum for the S&P 500 based on different CAPE ranges. The analysis highlights that the lower the entry valuation multiple, the higher the annual return for the 10 years thereafter (read