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An International Test of Common Stock Return Indicators

| | Posted in: Economic Indicators, Fundamental Valuation

Do any indicators systematically predict stock returns across global equity markets? In his June 2008 paper entitled “Predicting Global Stock Returns”, Erik Hjalmarsson tests the power of four common indicators (dividend-price ratio, earnings-price ratio, short interest rate and term spread) to predict stock returns for markets in 24 developed and 16 emerging economies. Using a very large dataset encompassing 20,000 monthly observations of returns and indicators ranging as far back as 1836, he concludes that:

  • Traditional valuation measures such as the dividend-price ratio and the earnings-price ratio have very limited power to predict stock returns in markets worldwide.
  • Economic indicators such as the short interest rate and the term spread are fairly robust predictors of stock returns, but only in developed markets.
  • The international results for the interest rate variables are similar to those in the U.S., while the findings for the valuation ratios are substantially weaker.

In summary, there is solid evidence that stock returns have a predictable component, captured at least partially by interest rate variables, across international markets.

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