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Abstract
The extant literature documents an inverse long-term relationship between the cyclically adjusted price/earnings ratio (CAPE) and 10-year S&P 500 forward returns. This article shows that a different price/earnings ratio—the relative total return CAPE (RTRC)—has short-term signaling value. During 1901Q1–2019Q4, tactically shifting from the S&P 500 to 10-year Treasury notes yields a 79% increase in terminal wealth relative to buy-and-hold. Several RTRC filters yield positive and statistically significant alphas and superior Sharpe and Treynor measures. From a time-series perspective, the RTRC is indistinguishable from a level stationary series, whereas the CAPE appears to have a unit root.
TOPICS: Security analysis and valuation, fundamental equity analysis, portfolio construction, performance measurement
Key Findings
▪ The article demonstrates the feasibility of tactically switching from the S&P 500 index to 10-year Treasury notes using the RTRC.
▪ The historical simulation yields a 79% increase in terminal wealth relative to buy-and-hold during 1901Q1–2019Q4.
▪ Several filters yield positive and statistically significant alphas and superior Sharpe and Treynor measures.
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US and Overseas: +1 646-931-9045
UK: 0207 139 1600