Jubilee Tectonic Model: Forecasting Long-Term Growth and Mean Reversion in the U.S. Stock Market
36 Pages Posted: 22 Apr 2018
Date Written: April 4, 2018
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
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