Forecasting Economic Fundamentals and Expected Stock Returns Using Equity Market Order Flows: Macro Information in a Micro Measure?

Abstract

This paper examines the information content of two different measures of aggregate equity-market order flow for future macroeconomic fundamentals and expected stock market returns. The first measure, the cross-sectional average of individual stock order flows, predicts future growth rates for industrial production and real GDP, but not for corporate earnings. The second measure, the difference between the average order flow for big stocks and the average order flow for small stocks, has strong forecast power for industrial production and real GDP, as well as corporate earnings, up to four quarters ahead. The significance of the two order flow-based measures is robust to controls for common equity pricing factors. This suggests a role for aggregate order flows in predicting stock returns. We show that a positive shock to the second factor, the order flow differential, forecasts higher returns for ten size sorted portfolios and greater market and size premiums in the subsequent quarter, even after accounting for a host of variables including the common return factors, experts' earnings growth forecasts, default and term spreads, new equity capital, and marketwide liquidity. These findings are consistent with a world where aggregate order flow brings together dispersed information from heterogeneously informed investors.