Jubilee Tectonic Model: Forecasting Long-Term Growth and Mean Reversion in the U.S. Stock Market

36 Pages Posted: 22 Apr 2018

See all articles by Stephen H.T. Lihn

Stephen H.T. Lihn

Atom Investors LP; Novus Partners, Inc.

Date Written: April 4, 2018

Abstract

We propose a long-term forecast model based on linear growth and mean reversion characteristics in the U.S. stock market. It can forecast future returns of the stock market, Treasury yield, and gold price. The “jubilee” name comes from its optimal trend-following window of 45 years. The “tectonic” name comes from the hypothesis that there are fault lines in the historical CAPE, which can be calibrated and corrected through statistical learning. The tectonically adjusted log-CAPE can be fully decomposed by a four-factor regression: two from mean reversion, two from inflation. This regression explains the mystery of lofty CAPE. These five factors form the forecast model for the 10 and 20-year future equity returns with high R-square above 80%. Major fault lines in CAPE are identified in each equity forecast model. We also analyze the causality in which the equity cycle leads both the Treasury yield and real gold price by 74 and 30 months. Therefore, their near-term direction can be predicted by extrapolating the regression. For longer horizon, we apply the factor model to forecast Treasury’s 20-year future yield and gold’s 20-year real return. A parsimonious triangular wave model is constructed to explain the periodicity of mean reversion in the past century. We conclude that the channel deviation is an universal mean-reversion variable among the three major asset classes.

Keywords: Forecast Model, Economic Cycle, Mean Reversion, CAPE, Stock Market, Interest Rate, Gold

JEL Classification: C38, C53, E32, E37, E47

Suggested Citation

Lihn, Stephen H.T., Jubilee Tectonic Model: Forecasting Long-Term Growth and Mean Reversion in the U.S. Stock Market (April 4, 2018). Available at SSRN: https://ssrn.com/abstract=3156574 or http://dx.doi.org/10.2139/ssrn.3156574

Stephen H.T. Lihn (Contact Author)

Atom Investors LP ( email )

3711 S Mopac Expressway
Austin, TX 78746
United States
917-603-4133 (Phone)

Novus Partners, Inc. ( email )

521 5th Ave
29th Floor
New York, NY 10175
United States
917-603-4133 (Phone)

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