Aggregation Consistency and Return Predictability: Evidence from CAPE Ratios

Rui Ma

Research

48 Pages

The authors argue that traditional CAPE has a hidden weighting problem because it uses earnings weights while market returns are value weighted. A value weighted Component CAPE built from S&P 500 constituents improves long horizon forecasts and asset allocation results.

Key Takeaways

CAPE Weighting Matters: The Component 10 year CAPE produced an out of sample R² of 57.52%, versus 46.67% for Aggregate CAPE.
Forecast Gains Persist: Component CAPE improved out of sample R² by 10.85 percentage points for 10 year earnings and 13.74 points for 5 year earnings.
Valuation Dispersion Drives Bias: The value weighted Component CAPE averaged 29.74, well above the Aggregate CAPE average of 21.65 across the sample.
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