To check whether or not variation within the earnings–worth correlation has any predictive worth for inventory returns, we ran regressions of correlation ranges in opposition to subsequent annualized returns.
The R² between S&P Composite earnings and worth from 1871 by way of 2024 could be very excessive at 0.95. Given the power of this long-term relationship—and the relative rarity of low-correlation intervals—it’s cheap to ask whether or not these intervals would possibly operate as purchase or promote alerts. In different phrases, does variation within the earnings–worth correlation assist predict future returns?
I evaluated this query throughout a number of rolling time horizons. The ensuing R² values — linking correlation ranges to subsequent annualized returns — have been far decrease than the R² between earnings and worth themselves. For the rolling 10-year and five-year home windows, the R² fell near zero, indicating nearly no predictive relationship.
The rolling 50-year interval confirmed the strongest relationship with a R2 of 0.53.
