Predicting Stock Market Return with Stocks-TIPS Yield Delta

Do deviations of the aggregate stock market earnings yield from the real government bond yield, as measured by the 10-year Treasury Inflation-Protected Securities (TIPS) coupon yield, predict future stock market returns? In the December 2024 draft of their paper entitled “An Investigation into the Causes of Stock Market Return Deviations from Real Earnings Yields”, flagged by a subscriber, Austin Murphy, Zeina Alsalman and Ioannis Souropanis examine the ability of the difference between current S&P 500 earnings yield and 10-year TIPS real (coupon) yield to predict S&P 500 Index excess returns (relative to 1-year U.S. Treasury notes) at horizons of 1, 5 and 10 years. They also investigate whether any of 25 variables, including inflation rate, drive stock market earnings yield and TIPS real yield apart. Using monthly data for the specified variables during January 1997 (limited by TIPS data) through December 2022, they find that: (more…)