The short term predictive ability of earnings-price ratios: The recent evidence (1994–2003)

Abstract

In this paper, I study the short-term predictive ability of earnings price ratios for the S&P 500 index from 94Q3 to 02Q4. Overall, I establish that both earnings price ratios levels and changes were effective in predicting index returns. However, I also uncover that this predictive effectiveness was quite volatile over the period. This finding may be interpreted either in a rational risk premium or an investor sentiment hypothesis. To examine the economic value of market timing using earnings price ratios, I implement both unconstrained and constrained trading strategies and uncover that, while market timing ability was the exclusive source of profits for the unconstrained strategies, positive market exposure accounted for a substantial portion of constrained strategies profits.