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
Date Written: January 1, 2020
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: Suggested Citation