We provide strong evidence of a countercyclical sensitivity of the stock market to major macroeconomic announcements. The most notable cyclical variation takes place within expansions: sensitivity is largest early in an expansion and essentially zero late in an expansion. By exploiting the comovement pattern between stocks and bonds around announcements, we show that the stock market sensitivity is large when the cash flow component of news is least offset by news about future risk-free rates. Observed fluctuations in stock sensitivities can be attributed to shifting perceptions of monetary policy responsiveness.

Does macroeconomic uncertainty increase or decrease aggregate growth and asset prices? To address this question, we decompose aggregate uncertainty into ‘good’ and ‘bad’ volatility components, associated with positive and negative innovations to macroeconomic growth. We document that in line with our theoretical framework, these two uncertainties have opposite impact on aggregate growth and asset prices. Good uncertainty predicts an increase in future economic activity, such as consumption, output, and investment, and is positively related to valuation ratios, while bad uncertainty forecasts a decline in economic growth and depresses asset prices. Further, the market price of risk and equity beta of good uncertainty are positive, while negative for bad uncertainty. Hence, both uncertainty risks contribute positively to risk premia, and help explain the cross-section of expected returns beyond cash flow risk.

We estimate a regime-switching model for the equity term structure with Bayesian methods. Our approach accounts for the data sample being unrepresentative of the population distribution of regimes. We find that (i) the term structure of expected equity dividend strip returns is downward sloping in recessions and upward sloping in expansions, and (ii) the unconditional term structure of expected equity returns is positively sloped. Our estimation shows that the sample unrepresentativeness induces a downward bias in the estimate of the equity term structure slope. We present a regime-switching consumption-based asset-pricing model that matches the empirical findings.