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How does the market interpret analysts' long-term growth forecasts?

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Abstract

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 (i) lower expected real earnings growth and (ii) 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. A one percentage point increase in expected inflation is estimated to raise required real stock returns about one percentage point, which on average would imply a 20 percent 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.

Suggested Citation

  • Steven A. Sharpe, 2002. "How does the market interpret analysts' long-term growth forecasts?," Finance and Economics Discussion Series 2002-7, Board of Governors of the Federal Reserve System (U.S.).
    • Handle: RePEc:fip:fedgfe:2002-7
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    1. Patricia M. Dechow & Amy P. Hutton & Richard G. Sloan, 2000. "The Relation between Analysts' Forecasts of Long†Term Earnings Growth and Stock Price Performance Following Equity Offerings," Contemporary Accounting Research, John Wiley & Sons, vol. 17(1), pages 1-32, March.
    2. John Y. Campbell & Robert J. Shiller, 1988. "Stock Prices, Earnings and Expected Dividends," Cowles Foundation Discussion Papers 858, Cowles Foundation for Research in Economics, Yale University.
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    4. James Claus & Jacob Thomas, 2001. "Equity Premia as Low as Three Percent? Evidence from Analysts' Earnings Forecasts for Domestic and International Stock Markets," Journal of Finance, American Finance Association, vol. 56(5), pages 1629-1666, October.
    5. Robert S.Harris & Felicia C. Marston, 1992. "Estimating Shareholder Risk Premia Using Analysts' Growth Forecasts," Financial Management, Financial Management Association, vol. 21(2), Summer.
    6. Campbell, John Y & Shiller, Robert J, 1988. " Stock Prices, Earnings, and Expected Dividends," Journal of Finance, American Finance Association, vol. 43(3), pages 661-676, July.
    7. Charles M. C. Lee & James Myers & Bhaskaran Swaminathan, 1999. "What is the Intrinsic Value of the Dow?," Journal of Finance, American Finance Association, vol. 54(5), pages 1693-1741, October.
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    9. William R. Nelson, 1999. "The aggregate change in shares and the level of stock prices," Finance and Economics Discussion Series 1999-08, Board of Governors of the Federal Reserve System (U.S.).
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    Cited by:

    1. Julia Lynn Coronado & Steven A. Sharpe, 2003. "Did Pension Plan Accounting Contribute to a Stock Market Bubble?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 34(1), pages 323-371.
    2. Ulrike Malmendier & Devin Shanthikumar, 2014. "Do Security Analysts Speak in Two Tongues?," Review of Financial Studies, Society for Financial Studies, vol. 27(5), pages 1287-1322.

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