Abstract
The relationships among real economic variables, monetary variables and financial variables have long been topics of active economic research. A simple discount model shows that the fundamental value of a firm’s stock equals the present value of expected future dividends. Future dividends must ultimately reflect real economic activity. If all currently available information is taken into account, there should be a close relationship between stock returns and expected future economic activity. To the extent that stock prices react quickly to new information about the future, stock prices should be a leading indicator of real economic activity, and the absence of any correlation between stock returns and future production growth rates would suggest that stock prices do not actually reflect the underlying fundamental value.1 For the USA, there is substantial evidence in favor of stock prices as a leading indicator of real economic activity.
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