This market-timing strategy uses the spread berween different credit bonds as an indicator to predict future stock market return. In this strategy, stocks are supposed to be sold when the credit spread rises above the predefinded threshold value, and vice versa. It also has “delay day” and “waiting day” settings.

    Fama and French (1989), among others, found the credit spread to be a sound predictor for future stock returns. The credit spread measure the attitude of investors towards the stock market. A decrease in the credit spread indicates lower risk aversion on the part of investors and therefore a good climate for the stock market. An increase in the spread indicates higher risk aversion on the part of investors and therefore a poor climate for the stock market. The spread between the yields on BAA-rated and AAA-rated corporate bonds is a widely used measure.

    Alternatively, we use the spread between the returns of the high yield bond index fund and the investment grade bond index fund as the indicator in this strategy. When investor thinks the risk is low and the matket is good, the prices of high yield bonds will go up and  the spread increases. Then we are supposed to buy stocks.

    So we will check the spread every day and consider the rise above a certain threshold as a signal to invest in S&P500 index (^GSPC), and vice versa. If the same switch signal persists for “delay days”, we switch the trading position. And in the succeeding “waiting days” we keep the position ignoring the new switch signals.

    We use VWEHX as high yield bond index fund and VWESX as investment grade bond index fund in default. Threshold can be certain fix values or SMA (Simple moving average) of certain days. And the Portfolio StartDate should not be set to the date earlier than 01/02/1990 due to lack of data.

 Parameters used in the created portfolio:

Indicator: Credit spread- the spread berween different credit bonds 

Threshold: 0 , 0.005, SMA 30days (default) , SMA 120days

Waiting days: 1 day, 5 days (default)

Delay days: 1 day, 5 days (default)

BuySecurity: ^GSPC(default), VFINX

Funds used in the portfolios: VWEHX (high yield bond index fund) and VWESX (investment grade bond index fund)

Similar Strategies in ValiFi:

• Market Timing Rule with Short Term Interest Rate: using the short-term interest rates as an indicator 
• Market Timing Rule with Maturity Spread: using the spread of long-term and short-term interest rates as an indicator 
• SMA Timing Method proposed by Faber: using the SMA of the target asset as an indicator
• High Yield Bond Timing Strategy: using  trend  triggers (percentages from recent high or recent low) of the asset price for buy and sell decisions
• The 125 05 Timing Model of High Yield Bond Strategy by Gerald Appel: using  predifined trend  triggers (percentages from recent high or recent low) of the asset price for buy and sell decisions
• Market Timing Rule with Long Term Interest Rate: using long-term interest rate as an indicator
• Market Timing Rule with Earning to Price Ratio: using the E/P ratio as an indicator
• Market Timing Rule with Dividend Yield: using the dividend yield as an indicator
• Market Timing Rule with Expected Inflation: using the expected inflation as an indicator
• Market Timing rule with Implied Volatility Index : using the implied volatility index  as an indicator  
• Market Timing Rule with Bond-Equity Yield Ratio : using the bond-equity yield ratio as an indicator 
• Market Timing Rule with Dividend Payout Ratio : using the dividend payout ratio as an indicator 
• Market Timing Rule with Put/Call Ratio:  using the put/call ratio as an indicator
• Learning Market Timing Rule: following the most profitable rule of the above simple market rules in each period 
• Voting Market Timing Rule : Switching the position if a certain percentage of the above simple market timing rules intends to do so.

See Also

Relative Working Papers: