We use a standard single-agent model to conduct a simple consumption growth accounting exercise.

[We use a standard single-agent model to conduct a simple consumption growth accounting exercise. Consumption growth is driven by news about current and expected future returns on the market portfolio. We impute the residual of consumption growth innovations that cannot be attributed to either news about financial asset returns or future labor income growth to news about expected future returns on human wealth, and we back out the implied human wealth and market return process. Innovations in current and future human wealth returns are negatively correlated with innovations in current and future financial asset returns, regardless of the elasticity of intertemporal substitution.]

[Evidence of stock-return predictability by financial ratios is still controversial, as documented by inconsistent results for in-sample and out-of-sample regressions and by substantial parameter instability. This article shows that these seemingly incompatible results can be reconciled if the assumption of a fixed steady state mean of the economy is relaxed. We find strong empirical evidence in support of shifts in the steady state and propose simple methods to adjust financial ratios for such shifts. The in-sample forecasting relationship of adjusted price ratios and future returns is statistically significant and stable over time. In real time, however, changes in the steady state make the in-sample return forecastability hard to exploit out-of-sample. The uncertainty of estimating the size of steady-state shifts rather than the estimation of their dates is responsible for the difficulty of forecasting stock returns in real time. Our conclusions hold for a variety of financial ratios and are robust to changes in the econometric technique used to estimate shifts in the steady state.]

Evidence of stock-return predictability by financial ratios is still controversial, as documented by inconsistent results for in-sample and out-of-sample regressions and by substantial parameter instability. This article shows that these seemingly incompatible results can be reconciled if the assumption of a fixed steady state mean of the economy is relaxed. We find strong empirical evidence in support of shifts in the steady state and propose simple methods to adjust financial ratios for such shifts. The in-sample forecasting relationship of adjusted price ratios and future returns is statistically significant and stable over time. In real time, however, changes in the steady state make the in-sample return forecastability hard to exploit out-of-sample. The uncertainty of estimating the size of steady-state shifts rather than the estimation of their dates is responsible for the difficulty of forecasting stock returns in real time. Our conclusions hold for a variety of financial ratios and are robust to changes in the econometric technique used to estimate shifts in the steady state.