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What? Are you Madoff? These days, anything related to 'low risk' or 'steady' returns generates skepticism. It is very understandable and perfectly reasonable for investors to have such a feeling, given what have happened in the financial industries.

However, if an investor does follow sound and safe investment principles consistently and disciplinarily, yes, Virginia, there is a hope! In the following, we will show how one could achieve a 10% return in the past 9 years by simply incorporating Buffett or Shiller long term stock market timing indicators in your investing.
The idea is simply that, when the stock market is significantly undervalued, one should fully invest in the stock market; when the stock market is significantly overvalued, one should sell the stocks and fully invest in bonds using some fixed income strategies. The proxy to invest in stock market is Wilshire 500 total return index while the strategies for fixed income investment are Alpha Dynamics for Multi Sector Bonds. This strategy evaluates 32 multi-sector bond mutual funds every quarter based on their trailing one year's Alphas and then select top 3 three funds for next quarter investment. The quarterly rebalancing frequency allows investors to avoid the short term redemption fee charged by brokerages or fund companies. It switches to Cash (13 week treasury bill) when none of the funds has positive 1 year alpha.

The following table illustrates the performances for the two portfolios from 12/31/2000 to 11/20/2009.

	Annualized Return	Standard Deviation	Maximum Drawdown
Buffett Indicator based Bond as Cash	12.73%	1.21	11%
Shiller Indicator based Bond As Cash	10.38%	11.1%	20%
Wilshire 5000 Total Return	-0.58%	22.2%	56.6%

A portfolio with much longer history (from 12/31/1990 to 11/20/2009) using Shiller's metric and alpha based high yield bond fund quarterly switch strategy shows a similar result (9.75% annualized return).

The above are just some of examples to show that if one is patient enough and avoids the hype in a long term period, he/she will be rewarded with  low risk reasonable returns.

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John Hussman, manager of Hussman Strategy Growth Fund (HSGFX) proposed price to peak 10 year average earnings as a long term stock market valuation gauge. Compared with the normal one year price to earning ratio, Price to Peak Earnings would eliminate short term noise. This is similar to Shiller's Cyclically Adjusted Price Earning ratio (CAPE10) and Warren Buffett's stock market GNP/GDP metric. In his weekly commentary on Dec 5, 2005, titled as 'Earnings Revert to the Mean, Stocks Will Struggle', he proposed a simplistic method: "buy when Price to Peak Earnings is lower than 15 and sell when it exceeds 19.5". John Hussman has been using this as the valuation yardstick to manage the Hussman Strategic Growth Fund HSGFX.
It is interesting to examine how effective using such a metric as a long term stock market timing indicator. Similar to the Warren Buffett's stock market GNP/GDP metric and Shiller's CAPE, the following strategy characterizes the stock market valuation into the following five categories based on the ratio of the current Peak PEs to the long term average Peak PEs:

• Significantly Overvalued (SO): such as if the ratio >= 150%
  
• Modestly Overvalued (MO): such as if   117% <=  ratio < 150%
  
• Fairly Valued (FV): such as if 83% <= ratio < 117%
  
• Modestly Undervalued (MU): such as if 67% <= ratio < 83%
  
• Significantly Undervalued (SU): such as if ratio < 67%

These five categories are determined by four valuation parameters (such as 150%, 117%, 83% and 67% in the above). At each rebalancing (adjusting) period (such as weekly or monthly), the strategy decides at what region the US stock market valuation is and then does the following rebalancing:

• SO: 0% in stock, 100% in cash.
  
• MO: 25% in stock, 75% in cash.
  
• FV: 50% in stock, 50% in cash
  
• MU: 75% in stock, 25% in cash
  
• SU: 100% in stock, 0% in cash

The stock market exposure is through buying Wilshire 5000 total return index (^DWC) or it could be set by users. Users could adjust the valuation parameters to get an effect like only buying at significantly undervalued (SU) level and selling at significantly overvalued (SO) level. Some of model portfolios of this strategy are:

• SO: >=150%, MO: [117%, 150%), FV: [83%, 117%), MU: [67%, 83%), SU: <67%
  
• SO: >=150%, MO, FV, MU: [67%, 150%), SU: <67%

A model portfolio called P Hussman Peak PE Market Timing Strategy Buy 15 Sell 19.5 Weekly is also maintained to live monitor the strategy suggested in 'Earnings Revert to the Mean, Stocks Will Struggle'.
The following table compares the performance of the three long term stock market indicators. All of the portfolios are based on 'buy at significantly undervalued and sell at significantly overvalued' strategy.

	12/31/1970 to 11/13/2009
Buffet GNP Metric Annualized Return	9.74%
Shiller CAPE10 Annualized Return	6.9%
Hussman Peak PE Annualized Return	8.02%
Wiilshire 5000 Total Return Annualized Return	6.9%
Buffet GNP Metric Sharpe Ratio	0.53
Shiller CAPE10 Sharpe Ratio	0.25
Hussman Peak PE Sharpe Ratio	0.33
Wilshire 5000 Total Return Sharpe Ratio	0.15

All of the strategies have achieved better returns and much higher Sharpe ratios compared with Wilshire 5000 total return index.

On Friday 11/13/2009, Both Buffett and Hussman metrics indicated the market was fairly valued: Buffet Total Stock Market Valuation to GNP ratio was 78.6% while Hussman's Peak PE10 to the long term Peak PE10 average was 1.04 (current peak PE 10 was 12.4 and the long term average was 11.9). Shiller CAPE10 to its long term average indicates the market was 22% overvalued.  It should be noted that John Hussman has been very cautious recently, pointing out the uniqueness of the current economic situation. Interested readers should read his latest weekly commentary here.

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In his 2001 Fortune magazine article, Warren Buffett used the ratio of the market value of all US publically traded securities to Gross National Product (GNP) as a yardstick to measure the stock market valuation. He stated that  

"The ratio has certain limitations in telling you what you need to know. Still, it is probably the best single measure of where valuations stand at any given moment".

He further went on to say

"If the percentage relationship falls to the 70% or 80% area, buying stocks is likely to work very well for you. If the ratio approaches 200%--as it did in 1999 and a part of 2000--you are playing with fire".

Such a simple yet elegant metric (we call it Buffett Stock Market Indicator) could be implemented in several ways. At the moment, ValidFi maintains a strategy called Warren Buffett Total Stock Market Value to GNP Ratio Strategy. This strategy characterizes the stock market valuation into the following five categories: 

• Significantly Overvalued (SO): such as if the ratio >= 115%.
• Modestly Overvalued (MO): such as if   90% <=  ratio < 115%.
• Fairly Valued (FV): such as if 75% <= ratio < 90%.
• Modestly Undervalued (MU): such as if 50% <= ratio < 75%.
• Significantly Undervalued (SU): such as if ratio < 50%

These five categories are determined by four valuation parameters (such as 115%, 90%, 75% and 50% in the above). At each rebalancing (adjusting) period (such as weekly or monthly), the strategy decides at what category the US stock market valuation is and then does the following rebalancing:

• SO: 0% in stock, 100% in cash.
• MO: 25% in stock, 75% in cash.
• FV: 50% in stock, 50% in cash.
• MU: 75% in stock, 25% in cash.
• SU: 100% in stock, 0% in cash.

The stock market exposure is through buying Wilshire 5000 total return index (^DWC) or it could be set by users. Users could adjust the valuation parameters to get an effect such as only buying at significantly undervalued (SU) level and selling at significantly overvalued (SO) level. Some of model portfolios of this strategy are:

• SO: >=115%, MO: [90%, 115%), FV: [75%, 90%), MU: [50%, 75%), SU: <50%.
• SO: >=115%, MO, FV, MU: [50%, 115%), SU: <50%.

The total US stock market valuation is based on Wilshire 5000 index while the GNP is based on Federal Reserve's quarterly released number. From 12/31/1980 to 9/18/2009, the weekly adjusted portfolio achieves 8.648% annualized return and standard deviation 12.2% compared with Wilshire 5000 total return's annualized return 7.4% and standard deviation 17.5%.

It is even more amazing if an investor opted to invest only when the market was significantly undervalued and went to cash when the market became significantly overvalued. Such a strategy would keep an investor in cash from 2/27/1998 to 3/6/2009: avoiding the last two bubbles altogether!  The following figure shows the transactions:

Such a portfolio achieves annualized return 9.71% with standard deviation 11.4% from 12/31/1980 to 9/18/2009. There are only 3 transactions during this whole 29+ year period.

On last Friday (9/18/2009), the Buffett Indicator stood at 77.5%,  valuing the US stock market as Fairly Valued if one uses the 5 categories above.

Along with Buffett Indicator, ValidFi recently introduced various financial, economic and sentiment indicators. Interested readers could find up to date information of these indicators on ValidFi's 360 Degree Market View page.

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