This study aims to clarify the mechanism of the surprising earnings-returns relation observed at the aggregate level by offering evidence from Japan. Unlike firm-level evidence, recent Macro-Accounting research reports that when earnings changes and stock returns of individual firms are cross-sectionally aggregated, a significantly positive relation cannot be observed in the U.S. market. To explain this puzzling finding, Kothari et al. (2006) propose a hypothesis that negative effects of changes in the market-wide cost of capital cancel out positive effects of aggregate earnings changes on aggregate stock returns. Although this hypothesis is empirically supported in the U.S market, the validity of this hypothesis has not been sufficiently investigated in the Japanese market. Thus, we test the hypothesis and find it robustly supported in Japan. Our results show that positive effects of aggregate earnings changes on aggregate stock returns are canceled out by the effects of the market-wide cost of capital. We also find that these canceling effects stem from the market risk premium in Japan. An additional test we conduct shows that expected aggregate earnings changes and changes in the market risk premium are JEL Classification: E44, G12, G14, M41

Our study proposes the usage of aggregate earnings to forecast future GDP growth. Using empirical analyses with global quarterly data, we investigate whether aggregate-level profitability drivers, which are components of aggregate earnings, are relevant for forecasting GDP growth. After confirming that aggregate-level profitability drivers are useful for forecasting future GDP growth worldwide, we show that considering the effects of crises improves the forecast model of GDP growth. In addition, we suggest that predicting GDP growth using aggregate-level profitability drivers is relevant for stock valuation in developed countries, but not in emerging countries.

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