Tactical Asset Allocation with the Relative Total Return CAPE

The extant literature documents an inverse long-term relationship between the cyclically adjusted price/earnings ratio (CAPE) and 10-year S&P 500 forward returns. This article shows that a different price/earnings ratio-the relative total return CAPE (RTRC)-has short-term signaling value. During 1901Q1-2019Q4, tactically shifting from the S&P 500 to 10-year Treasury notes yields a 79% increase in terminal wealth relative to buy-and-hold. Several RTRC filters yield positive and statistically significant alphas and superior Sharpe and Treynor measures. From a time-series perspective, the RTRC is indistinguishable from a level stationary series, whereas the CAPE appears to have a unit root.