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todd, a very smart very very very rich and very famous trader once told me

"if your theory can be tested then it should be tested otherwise it is not a theory, only a conjecture"

And let me guess, then she asked you when you were going to take out the garbage/mow the lawn/change a diaper, right?

My problem is that I don't know any smart or rich traders, so I gotta troll for whatever feedback I can get here on TMF. So I'm glad you dropped by.

By testing do you mean back-testing with historical data, or forward testing with an active trading program? I'm hindered a bit in the former because I haven't found a good source of bond data that goes well back into the last secular bear market. And I'm hindered a bit in the latter because I've still got most of our equity tied up in an extra house.

But as far as using the Fed Model to time asset allocation in the S&P, I can use Shiller's and Yardeni's data from Jan 79 to take a pretty good stab at annualized returns for quarterly holding periods starting at > +30% overvaluation, > +15%, +15 to -15, < 15% undervaluation, and < 30% undervaluation. Annualized rate of returns include dividends, although they're not compounded (would really only matter for a couple of long holding periods in the 80's).

Valuation %Stocks #Periods #Qtrs AROR

+30% 30 2 6 0.914
+15% 40 5 10 1.104
0% 50 8 56 1.144
-15% 60 6 14 1.226
-30% 70 2 6 1.189

So, I think it's got promise, even without knowing exactly what was happening on bonds. And as for using options, I have no ability whatsover to backtest this, but I know that selling volatility to others was a profitable thing to do in Aug-Oct 98, Mar-Jun 2000 (less so), Sept 2001, and I'm guessing right now in Jul 2002.

Notwithstanding the need for rigorous statistical backtesting, the really hard part of following this program would be the psychological discipline required. For example, to ramp down equities in March of 1999 and then watch the SPX run up another 200 points would have been tough. Or to add money at the end of June only to watch 250 points get lopped off as of today.

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