ber of months before (or after) a business cycle trough. Buy-and-hold re-
turnsare defined as the returns from holding the market through the en-
tire business cycle. Excess returnsare defined as switching returns minus
the returns from the buy-and-hold strategy.^7
Over the entire period from 1802 through 2006, the excess returns
are minimal over a buy-and-hold strategy if investors switch into bills
exactly at the business cycle peak and into stocks exactly at the business
cycle trough. In fact, investors switching into bills just one month after
the business cycle peak and back into stocks just one month after the
business cycle trough would have lost 0.6 percent per year compared to
the benchmark buy-and-hold strategy.
Interestingly, it is more important to be able to forecast troughs of
the business cycle than it is peaks. An investor who buys stocks before
the trough of the business cycle gains more than an investor who sells
stocks an equal number of months before the business cycle peak.
The maximum excess return of 4.8 percent per year is obtained by
investing in bills four months before the business cycle peaks and in
stocks four months before the business cycle troughs. The strategy of
switching between bills and stocks gains almost 30 basis points (^30 ⁄ 100 of a
CHAPTER 12 Stocks and the Business Cycle 215
TABLE 12–4
Switching Returns (Percent) Minus Buy-and-Hold Returns (Percent) around Business Cycle Turning
Points, 1802 through December 2006
4 month 3 month 2 month 1 month 1 month 2 month 3 month 4 month
4 month 4.8 4.0 4.2 4.1 3.3 2.7 2.1 2.2 1.9
3 month 4.0 3.3 3.5 3.3 2.6 1.9 1.4 1.5 1.3
2 month 3.3 2.6 2.8 2.6 1.9 1.2 0.7 0.8 0.7
1 month 2.5 1.8 2.0 1.8 1.1 0.5 0.0 0.1 0.0
1.9 1.2 1.4 1.2 0.5 -0.2 -0.7 -0.6 -0.7
1 month 1.5 0.8 1.0 0.8 0.1 -0.6 -1.1 -1.0 -1.1
2 month 0.9 0.2 0.4 0.2 -0.5 -1.1 -1.7 -1.6 -1.7
3 month 0.5 -0.2 0.0 -0.2 -0.9 -1.5 -2.1 -2.0 -2.1
4 month 0.3 -0.4 -0.2 -0.3 -1.1 -1.7 -2.2 -2.1 -2.2
Switching from Bills to Stocks before Trough
At Trough
Switching from Bills to Stocks after Trough
Switching from Stocks to Bills before Peaks At
Peak
Switching from Stocks to Bills after Peaks
(^7) The returns of the buy-and-hold strategy are adjusted to reflect the same level of market risk as the
buy-and-hold strategy.