Are stock prices driven by expected growth rather than discount rates? Evidence based on the covid-19 crisis

We use the Gordon (Rev Econ Stat 41(2):99-105, 1959) constant growth model to gauge the efects from innovations in implied growth versus discount rates. Dur- ing the COVID-19 downturn and the Global Financial Crisis (GFC), stock returns were largely afected by a change in the long-run implied growth rate and only to a lesser extent by a change in discount rate, the latter typically used to explain stock returns in the classical asset pricing literature. We reach this conclusion by using ordinary least-squares (OLS) regressions of stock returns on the unobservable Gor- don factors, which we estimate from irm-level valuation ratios D/P, P/E, and P/B. The efects from a decrease in implied growth outweigh those from an increase in discount rate by a factor of approximately 1.6 to 1.7. Also, irms with a decrease in implied growth show a stock return that is approximately 6.6% more negative than that of irms with no decrease in implied growth. Investors can infer valuable infor- mation from the joint interpretation of underlying market fundamentals as derived from the Gordon model.