From Macro Fugue:
Anyone who has spent much time with a quantitative tool trying to regress data points against future returns already knows: nearly nothing works.
It also seems to be substantially easier (read: still quite difficult) to find relationships which predict returns over an investable time frame.
The best fits seem to be over 10 or 15 years. This:
The surest way of making a fool of yourself is to predict the future. The folly of prediction probably has an exponential relationship with expanding time frames.
- reduces the sample size, making the veracity of the regression demonstrating causation dubious
- makes it very difficult to forward test
- even with the tightest past explanatory power, does not account for the massive developments and shifts in behavior which occur on a regular basis
With that said, I present two compelling long-run regressions.
First up is the “M/O” ratio (the ratio of the middle-age cohort, age 40–49, to the old-age cohort, age 60–69), as defined in the San Fransisco Fed paper, regressed against the P/E ratio:
It is an explainable relationship: it evidences that marginal asset preference is demographically driven. And that we can certainly further rationalise: our demands for return and safety (which are usually mutually exclusive), as well as our income, are reasonably predictable. The middle-aged cohort has the most income to invest, but not yet the preference for capital preservation that retirees and the soon-to-retire cohort demonstrate.
Some criticisms I’d level at this explanation...MUCH MORE