This paper provides strong evidence of time-varying return predictability of the S&P 500 Index from 1929 to 2020, by proposing the construction of altered versions of the classical dividend- price (dp) and earnings-price (ep). Our primary objectives include the introduction of a cyclical
adjustment to the simple dp and ep, which would smoothen dividends and earnings, he comparison of the predictive dynamics of these new ratios with their simple counterparts and the modification of all ratios based on long-run equilibrium relationships that arise between the examined variables. We provide solid evidence that the cyclically-adjusted ratios perform better than the simple predictors in all forecasting horizons both in and out-of-sample, and the modified variables capture more predictive components in returns. We also examine dividend and earning growth predictability and through certain robustness checks including multivariate regression settings, evidence on excess and real return predictability, and a structural break analysis, we thoroughly present the predictive components identified in our data set.

Keywords: cyclically-adjusted ratios; return predictability; cointegration testing; dividend and earnings growth predictability; structural break analysis

JEL classification: G11, G12, G13, G14, G17