Although both stock and bond market data contain information relevant for predicting GNP growth, the bond market delivers more accurate predictions. While yield curve measures are able to explain more than 30 per cent of the variation in economic growth over the 1953–89 period, stock market variables explain only about 5 per cent. Furthermore, forecasts based on the yield curve compare favorably with forecasts from leading econometric models, whereas forecasts from stock market models do not.
Inasmuch as firms’ earnings are positively correlated with economic growth, one might expect that stock prices would contain information about real economic activity. But variations in stock prices can reflect both changes in expected economic growth and changes in the perceived risk of stock cash flows. Investors’ changing perceptions about the riskiness of cash flows can confound the information about expected economic growth.
A yield-based forecast for the third quarter of 1989 through the third quarter of 1990 suggests a slowing of economic growth, but not zero or negative growth.
