CAPE Valuation Across Macro Regimes and Risk Parity Robustness

Summary

This research digest reviews two portfolio topics. The first concerns Shiller’s cyclically adjusted price-to-earnings ratio (CAPE): it can help forecast long-run equity returns as valuations tend to mean-revert, but its short-term signal is unreliable when macroeconomic conditions shift. Drawing on earlier findings about real interest rates and valuation, the paper proposes comparing CAPE with the average for the current macroeconomic regime rather than with a single long-run average to improve short-horizon return forecasts.

The second topic compares risk parity with other asset allocation approaches. The report describes risk parity as robust across risk balancing and historical periods, while emphasizing that results depend on which asset classes are included and on their Sharpe ratios. It attributes much of the strategy’s strong performance in the US over the preceding two decades to the long bond bull market. These are reported research conclusions; the underlying paper and its detailed methodology are not included in the document, so the claims cannot be independently assessed here.

Key ideas

• CAPE may be more informative for long-term returns than short-term returns when valuations are compared with a single historical average.
• Forecasting CAPE relative to macroeconomic regime-specific averages may improve short-term return prediction.
• Risk parity is described as robust across risk balancing and different historical periods.
• Risk parity outcomes are sensitive to asset selection and the return quality of the included assets.
• Its historical US performance was closely linked to a prolonged bond bull market.

Tags

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.