Does money supply growth contain predictive power for stock returns? Evidence and explanation

Citation

McMillan D (2017) Does money supply growth contain predictive power for stock returns? Evidence and explanation. International Journal of Banking, Accounting and Finance, 8 (2), pp. 119-145. https://doi.org/10.1504/IJBAAF.2017.087077

Abstract
We examine the nature of predictive power of money supply growth for stock returns. An understanding of which will be useful for market practitioners and policy makers given the current lack of consensus. In addition, knowledge of this relation can aid our understanding of the risk and cash flow channels of stock price movement. Using monthly data and considering a range of alternative predictor variables, predictive and forecast time horizons, empirical methodologies and measures of stock returns, we find that money supply growth has a negative predictive relation with stock returns. Rolling window forecasts provide confirmatory out-of-sample evidence for the significance of money supply growth as a predictor variable. The use of both returns and dividend growth predictive regressions, as well as a VAR analysis and predictive regressions for size and book-to-market portfolios suggest that relation operates through a risk channel. Higher money supply leads to improving economic conditions and lower (required) returns.

Keywords
stock returns; money supply; predictability; asset price movement; forecasting

Journal
International Journal of Banking, Accounting and Finance: Volume 8, Issue 2