Stock Market "Prediction" Models
This study compares the equity allocation model relative to the more popular PE, Shiller CAPE, yield spread, Fed Model, and Buffet's Ratio (Market Cap/GDP) to predict long-term stock market returns. Although all the variables are related to long-run stock returns, only equity allocation and yield spread have root mean square errors consistently lower than a simple moving average. A simple trading rule transferring wealth between equity and 10-year T-bonds demonstrates equity allocation performs best with a 1.3% annual outperformance relative to buy-and-hold from 1990 to 2018. However, the predictive ability of the ratio was not identified until 2013 and since then, the trading strategy has underperformed by 1.5% annually. Thus, despite equity allocation's initial glamour, its long-term predictive ability does not appear to be easily transformed into profitable trading.
Shelley, Garry L.; Traian, Anca; and Trainor, William J.. 2020. Stock Market "Prediction" Models. Economics Bulletin. Vol.40(2). 1548-1556.