Reexamining Stock Valuation and Inflation: The Implications Of Analysts' Earnings Forecasts

By Steven A. Sharpe. Review of Economics and Statistics, 2002

206 citations recorded by the source corpus.

This paper examines the effect of inflation on stock valuations and expected long-run returns. Ex ante estimates of expected long-run returns are constructed by incorporating analysts' earnings forecasts into a variant of the Campbell-Shiller dividend-price ratio model. The negative relation between equity valuations and expected inflation is found to be the result of two effects: a rise in expected inflation coincides with both lower expected real earnings growth and higher required real returns. The earnings channel mostly reflects a negative relation between expected long-term earnings growth and expected inflation. The effect of expected inflation on required (long-run) real stock returns is also substantial. An increase of one percentage point in expected inflation is estimated to raise required real stock returns about one percentage point, which on average would imply a 20 decline in stock prices. But the inflation factor in expected real stock returns is also in long-term Treasury yields; consequently, expected inflation has little effect on the long-run equity premium.

Subfields: Economics and Econometrics, Finance, Strategy and Management

View Paper: https://www.semanticscholar.org/paper/368810e647954f1103245c7c6dab86527bae20fb

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Citations in the corpus

The GSE implicit subsidy and value of government ambiguity (2003, unknown): “My measure of the equity premium is constructed with equity analyst earnings forecasts, employing an approach similar to that used in Sharpe (2002).”
What Ties Return Volatilities to Price Valuations and Fundamentals? (2013, unknown): “Sharpe (2002) uses operating earnings and analysts estimates of these earnings to study stock P/E valuations and returns.”
Investor Sentiment, Limits to Arbitrage and Private Market Returns (2014, background): “…U.S. Treasury securities, the slope of the Treasury term structure of interest rates, the spread between yields on BAA- and AAA-rated corporate bonds and the rate of inflation (e.g., Chen, Roll and Ross 1986, Ferson and Harvey 1991, Fama and French 1993, Fama and Schwert 1977, Sharpe 2002).”
Inflation and the Stock Market: Understanding the 'Fed Model' (2009, background): “…(2005)), both practitioners and academics have concluded that the model is inconsistent with a rational valuation of the stock market (see for instance, Asness (2003), Feinman (2005), Campbell and Vuolteenaho (2004), Cohen, Polk and Vuolteenaho (2005), Ritter and Warr (2002) and Sharpe (2002)).”
Asset Pricing with Fading Memory (2019, unknown): “Long-term earnings growth rates in the I/B/E/S data are meant to represent an expected growth rate over the next three to five years, or a “full business cycle” (see, e.g., Sharpe (2002)).”