Some international evidence on stock prices as leading indicators of economic activity

Most asset pricing theories suggest that asset prices are forward looking and reflect market expectations of future earnings. By aggregating across companies, aggregate market prices may then be used as leading indicators of future growth in aggregate income, as well as its constituent components. Data are compiled from 23 countries, including 15 developing countries, in order to examine the ability of stock market prices to predict future economic growth in income, consumption and investment. It is found that stock prices generally have predictive ability, but with substantial variation across countries. Moreover, stocks are substantially better leading indicators of investment than either GDP or consumption. Despite their value as leading indicators, however, stock prices do not generally increase forecasting ability as measured by root mean squared error in out-of-sample forecasting equations.