The stock market is way more predictable than the textbooks say, as long as you ignore those 'permanent' growth trends.
The famous 'random walk' theory suggests markets are hard to predict. This paper argues that the standard metric (price-dividend ratio) is just 'noisy'; when you filter out long-term trends in cash flow, the market's return becomes highly predictable, explaining 22% of the variance over a five-year horizon.
Expected Returns with Trends and Cycles
SSRN · 6332619
We argue that cash flow growth contains a permanent trend component, rendering the price-dividend ratio a noisy proxy for expected returns. Jointly filtering trend growth, cash flow cycles, and expected returns via an Extended Kalman Filter, we show this cash flow noise generates severe attenuation bias in standard predictive regressions. Purging cash-flow trends and cycles restores return predictability, delivering out-of-sample R 2 of 9% at one-year and 22% at five-year horizons, where traditi