Swedish Stock Returns and the Cyclically Adjusted Price to Earnings Ratio

Evidence from the U.S equity market shows that the cyclically adjusted price to earnings ratio (CAPE) is a strong predictor of future long-horizon stock returns. This paper focuses attention on the Swedish equity market to see whether the CAPE-ratio is applicable to the Swedish market. Furthermore, to see whether a set of secondary explanatory variables may strengthen the predictive power additionally. The assessed variables, besides CAPE, are the price to book ratio, the purchasing managers’ index and long/short interest rates. A quantitative econometric approach is enforced with specific focus on index returns predictability with respect to CAPE. The main results establish that only a short-term relationship is found. The relationship grows stronger as the return-horizon increases but the practical relevance of this knowledge is partly ruined given the fact that the models are estimated in first differences. The results may only indicate how monthly returns are likely to develop in relation to monthly returns seen today, on a month-to-month basis. Further concluded is the fact that all secondary variables turn out statistically insignificant in the majority of the proposed models. Amongst the assessed variables, CAPE is the best predictor of short-term future return movements