Do stock prices follow interest rates or inflation?

David G. Bishop and John E. Golob

No 96-13, Research Working Paper from Federal Reserve Bank of Kansas City

Abstract: Market analysts often forecast changes in stock prices by comparing earnings-price ratios on stocks to nominal interest rates. This paper shows that stock prices have followed inflation more closely than interest rates over the last thirty years. This result has implications for recent stock valuations, because the spread between nominal interest rates and inflation has recently been above historic averages. That is, stock prices appear more overvalued when the earnings-price ratio is compared to nominal interest rates than when the earnings-price ratio is compared to inflation. Our result also helps explain the behavior of stock prices during the 1970s.

Keywords: Inflation (Finance); Interest rates; Stock - Prices (search for similar items in EconPapers)
Date: 1996
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