Stock Return Predictability and Seasonality

Abstract

An examination of the Shiller cyclically adjusted pricing-earnings (CAPE) ratio reveals its forecasting power for 12-month CRSP equally weighted (EW) excess returns and value weighted (VW) excess returns. The 12-month EW excess returns following low CAPE ratios are, on average, 20.7% higher than those following high CAPE ratios for the period of 1927-2016. This dichotomy in the Shiller CAPE ratio has a more reliable predictability than the January barometer. Previous studies report that the Halloween indicator was weak or negative in the US stock market prior to the 1950s. We find that the Halloween effect is strongly present following high CAPE ratios, even for the period of 1926-1971. Our results recommend a practical investment strategy. More specifically, if the CAPE ratio in September is lower than the 36-month median of the CAPE ratio, invest in stock markets from November to October of the following year; otherwise, invest for six months from November to April and sell in May and go away.