Does the CAPM Predict Returns?

We provide empirical evidence that CAPM-betas positively predict asset returns when market returns are predicted to be high, which occurs about every other month. Consequently, the product of beta and the predicted market return (CAPM) predicts asset returns by combining the out-of-sample forecasting power of both beta and the market return predictor. Monthly out-of-sample R2s are substantial for both portfolios and individual stocks and translate into large trading gains. Indeed, trading strategies exploiting the forecasting power of the CAPM have Sharpe ratios up to 100% larger than the corresponding buy-and-hold strategies, and their average returns increase with their CAPM-betas.