How Cyclical Are Stock Market Return Expectations? Evidence from Capital Market Assumptions

Abstract

We collect return expectations from the capital market assumptions of asset management firms that manage a combined USD 21.6 trillion in 2020. Consistent with leading rational expectations asset pricing models, asset managers' subjective equity premium expectations are high when valuations are low and low when valuations are high (countercyclical), and the term structure of subjective equity premium expectations is downward sloping when valuations are low and upward sloping when valuations are high (procyclical). As U.S. equity valuations increased over the last decade, the ten-year expected U.S. equity premium declined from 4.3% per year at the beginning of the decade to 3.4% per year at the end of the decade and temporarily spiked by 2.4 percentage points during the COVID-19 induced market sell off in March 2020.