This Simple Metric Could Predict Future US Stock Market Returns

A groundbreaking study, published in the September 2025 issue of the International Review of Economics & Finance, reveals that a surprisingly simple metric—the difference between current S&P 500 earnings yield and long-term real Treasury Inflation-Protected Securities yield—has significant power to possibly predict stock market returns.

The research demonstrates that when actual returns deviate from this baseline prediction, these deviations are systematically related to inflation, monetary policy, and economic fundamentals, offering investors a new lens for understanding market dynamics.

Stock Market Return Expectations

The authors, Austin Murphy, Zeina N. Alsalman, and Ioannis Souropanis, set out to solve a fundamental puzzle in finance: Why do stock market returns sometimes diverge dramatically from what economic theory would predict based on earnings yields?

Their investigation centered on a simple relationship: the difference between the current earnings yield on the S&P 500 (the inverse of the price/earnings ratio) and the long-term real TIPS yield. This gap, they hypothesized, should provide insight into expected stock returns. But when actual returns deviate from this prediction, what drives those deviations?

The research team analyzed how various economic factors (including inflation rates, money supply growth, output gaps, and monetary policy changes) correlate with periods when stock returns significantly over- or underperform relative to earnings yield expectations. Their data sample goes from January 1997 (the first month in which 10-year TIPS appeared) through December 2022.

Key Findings: The Hidden Patterns in Market Deviations

The researchers discovered five key findings:

1. The Power of the Earnings Yield-TIPS Gap

The researchers discovered that the simple difference between S&P 500 earnings yield and long-term real TIPS yield has significant predictive power on that stock market index over both short-term and long-term investment horizons—explaining ex-ante about half of the variation in those returns over subsequent 10-year horizons.

2. Inflation’s Dual Nature

One of the study’s most intriguing findings concerns inflation’s complex relationship with stock return deviations—a story of short-term pain and long-term gain. It found that:

• Recent inflation hurts stock performance: When current inflation rates are high, stock returns tend to fall short of earnings yield predictions over annual investment horizons. This is consistent with restrictive monetary policy being implemented at those times.
• Past inflation benefits future returns: Conversely, higher historical inflation rates are associated with stock returns that exceed earnings yield predictions over longer periods.

The short-term pain is when current inflation runs hot, stocks tend to underperform relative to what the earnings yield gap predicts because high inflation triggers restrictive Federal Reserve policies, raising discount rates and pressuring future profit growth. The result is that stocks tend to stumble despite rising nominal earnings.

But there’s a long-term gain. Historical inflation tells a different story. Stocks that suffered during past inflationary periods tend to outperform earnings yield predictions over subsequent years. Why? Because the economic adjustments and Fed responses to past inflation often create conditions favorable for future equity performance.

This dual nature of inflation’s impact helps explain why stocks can struggle during inflationary periods but may be positioned for strong future returns.

3. Economic Slack: The Hidden Return Driver

Deviations from their theoretical identity for the equity premium were positively related to current economic slack in the economy. When the economy operates below capacity—think high unemployment or underutilized industrial capacity—the model consistently underestimates future stock returns. Conversely, when the economy runs hot with little slack, stocks often underperform predictions.

4. Monetary Policy’s Predictable Impact

The research reveals clear connections between monetary policy and market deviations.

When the Fed tightens (raising rates, slowing money growth), future inflation typically falls. However, this also means stocks will likely underperform the earnings yield prediction in the near term as higher discount rates and tighter financial conditions weigh on earnings and valuations.

Expansive monetary policy, however, often leads to stock returns that exceed earnings yield predictions, particularly over one-year horizons. The extra liquidity inflates asset values beyond what fundamentals alone would justify.

5. The Money Supply Connection

Money growth emerges as a significant factor in explaining return deviations. Over annual periods, higher money supply growth is associated with stock returns that exceed earnings yield predictions, suggesting that monetary expansion can temporarily boost equity valuations beyond fundamental levels.

Their findings led the authors to conclude: “The findings of this study supply new empirical insights into the intertemporal interrelationships between stock returns, inflationary pressures, monetary policy, and profit growth. They support the hypothesis that short-term negative deviations of stock market returns from an otherwise positive relationship with real good prices stem from anti-inflationary policies. Those policies raise interest rates and lower real money growth in the future when inflationary pressures are higher. Such tighter monetary conditions impede future profit growth, concurrently with elevating the discount rates on future cash flows to stockholders. Consequently, diminished stock market returns occur during times of heightened consumer price increases, despite profits and stock returns being positively related to inflation otherwise.”

Important Limitations and Considerations

While this research offers valuable insights, investors should be aware of several important limitations that may affect the reliability of these findings:

• Limited Historical Data: The study’s analysis spans only 25 years (January 1997 through December 2022), yet the authors use five-year and 10-year regression periods to assess predictive power. With such a limited timeframe, there are relatively few nonoverlapping data points for long-term analysis—essentially just two to five independent 10-year periods. This small sample size makes it difficult to establish robust statistical confidence in the long-term predictive relationships, and the results may not hold up across different market cycles or economic regimes that weren’t captured in this relatively short period. For example, bond yields were falling for almost the entire sample period. What happens when yields rise?
• Earnings Methodology Questions: The researchers used “past maximum year-over-year earnings” rather than current or forward-looking earnings in their calculations. This backward-looking approach may not accurately reflect current market conditions or investor expectations, potentially skewing the predictive power of the earnings yield gap. Current earnings or consensus forward earnings might provide a more relevant baseline for predicting future returns, as they better reflect the market’s present valuation and near-term prospects.

These limitations don’t invalidate the study’s insights, but they do suggest that investors should view this framework as one tool among many rather than a definitive market timing mechanism.

Key Takeaways for Investors

1. Use the Earnings Yield Gap as a Gauge of Fundamental Market Valuation and Future Expected Returns

Investors can monitor the difference between S&P 500 earnings yield and long-term real TIPS yield as a gauge of market valuation. When this gap is unusually wide, it may signal that stocks are either significantly over- or undervalued relative to bonds.

2. Consider Inflation’s Timeline Effects

Understanding inflation’s dual impact can help investors navigate inflationary environments more effectively:

• Don’t panic during high-inflation periods when stocks underperform—this may set the stage for future outperformance.
• Recognize that low-inflation environments might not always favor stocks if they’ve been preceded by extended periods of price stability.

3. Watch Federal Reserve Policy Closely

The research confirms that monetary policy changes have predictable effects on stock market performance relative to fundamental valuations. Investors should pay particular attention to:

• Interest rate trajectories and their impact on the earnings yield-TIPS spread
• Money supply growth rates as indicators of potential market overvaluation
• The Fed’s inflation targeting policies and their long-term implications for equity returns

4. Adopt a Multiyear Investment Horizon

The predictive power of earnings yield relationships works best over multiyear periods, not for short-term trading. Investors should:

• Use this framework for strategic asset allocation rather than tactical timing.
• Be patient when valuations suggest stocks are attractive relative to bonds.
• Recognize that short-term deviations can persist for extended periods.

Predictive Power

This research contributes to a growing body of evidence that markets, while generally efficient over long periods, can experience systematic deviations from fair value that create opportunities for informed investors. The earnings yield-TIPS gap provides a simple, yet powerful, framework for identifying these opportunities.

Perhaps most importantly, the study demonstrates that these market deviations aren’t random—they follow predictable patterns related to inflation, monetary policy, and economic fundamentals. This insight can help investors navigate market cycles with greater confidence and potentially improve long-term returns.

For individual investors, the key is not to try to time these deviations perfectly, but rather to understand the underlying economic forces at work and position portfolios accordingly. By monitoring the earnings yield gap and staying attuned to inflation and monetary policy trends, investors can make more informed decisions about when stocks may be attractively valued relative to bonds and other asset classes.

As a final note, as of the end of Jan. 3, 2026, the difference between the earnings yield on the S&P 500 (about 3.2%) and the real yield on 10-year TIPS (about 1.9%) was only about 1.3%. Adding the 1.3% gap to the current 3.7% yield on one-month Treasury bills provides an expected nominal return to the S&P 500 of 5.0%, well below the historical average return of about 10.5%. Importantly, this doesn’t mean a crash is imminent. However, it does suggest that investors should temper their return expectations and perhaps consider diversification strategies that don’t rely solely on continued stock market appreciation.