What Actually Predicts the Market

From Macro Fugue:

(Not much)
 
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: 

1. reduces the sample size, making the veracity of the regression demonstrating causation dubious
2. makes it very  difficult to forward test
3. even with the tightest past explanatory power, does not account for the massive developments and shifts in behavior which occur on a regular basis

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.

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