The Role of Future Economic Conditions in the Cross-Section of Stock Returns: Evidence From the US and UK

Forthcoming, Research in International Business and Finance

28 Pages Posted: 2 Mar 2020

See all articles by Sheng Zhu

Sheng Zhu

Willis Towers Watson - The Asset Management Exchange

Jun Gao

University College Cork

Meadhbh Sherman

University College Cork

Date Written: January 1, 2020

Abstract

Our study investigates the explanatory power of future economic conditions on individual stock returns in the US and UK equity markets. We analyse a new trading strategy that is based on rational forecasts of future real activity. In addition, we specifically examine the performance of this trading strategy applied to two different classifications of stocks – procyclical stocks and countercyclical stocks. Our findings indicate a strong persistence in the relationship between returns on pro-cyclical stocks and the business cycle. However, such persistence is not present when moving to counter-cyclical stocks in the US and the UK. From this we suggest that US and UK equity investors who predict future real activity accurately can improve their investment profitability by longing pro-cyclical stocks when they expect future economic conditions to be above the long-run trend and shorting those stocks when future activity is anticipated to be below the steady state.

Keywords: Pro-cyclical, counter-cyclical, future economic conditions, expectations

JEL Classification: G12

Suggested Citation

Zhu, Sheng and Gao, Jun and Sherman, Meadhbh, The Role of Future Economic Conditions in the Cross-Section of Stock Returns: Evidence From the US and UK (January 1, 2020). Forthcoming, Research in International Business and Finance, Available at SSRN: https://ssrn.com/abstract=3530363 or http://dx.doi.org/10.2139/ssrn.3530363

Sheng Zhu (Contact Author)

Willis Towers Watson - The Asset Management Exchange ( email )

2nd Floor
85 South Mall
Cork, Munster T12 A3XN
Ireland

Jun Gao

University College Cork ( email )

5 Bloomfield Terrace Western Road
Cork
Ireland

Meadhbh Sherman

University College Cork ( email )

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