Misery on Main Street, Victory on Wall Street: Economic Discomfort and the Cross-Section of Global Stock Returns

Abstract

This study argues that local economic discomfort influences investors’ risk-aversion, leading to a cross-sectional variation of equity risk premia around the world. To test this assertion, we use the popular Misery Index, which aggregates unemployment and inflation rates, as a gauge of macroeconomic welfare. Using data from 65 stock markets for the years 1960–2019, we demonstrate that economic discomfort reliably predicts future equity returns in the cross-section. A quartile of countries with the highest Misery Index outperform the countries with the lowest Misery Index by 0.65% per month. The phenomenon is not subsumed by a battery of established return predictors and proves robust to many additional checks. The effect is stronger in countries where prices are set primarily by local investors and where uncertainty avoidance is high. Finally, this economic discomfort premium can be successfully harvested with liquid exchange-traded funds.

Keywords: Equity Indices, International Markets, Asset Pricing, Equity Anomalies, Return Predictability, the Cross-Section of Stock Returns, the Misery Index, Economic Discomfort Index, Unemployment, Inflation

JEL Classification: G11, G12, G14, G15, E3, E24, I31