Can macroeconomic variables explain long term stock market movements? A comparison of the US and Japan

Within the framework of a standard discounted value model we examine whether a number of macroeconomic variables influence stock prices in the US and Japan. A cointegration analysis is applied in order to model the long term relationship between industrial production, the consumer price index, money supply, long term interest rates and stock prices in the US and Japan. For the US we find the data are consistent with a single cointegrating vector, where stock prices are positively related to industrial production and negatively related to both the consumer price index and a long term interest rate. We also find an insignificant (although positive) relationship between US stock prices and the money supply. However, for the Japanese data we find two cointegrating vectors. We find for one vector that stock prices are influenced positively by industrial production and negatively by the money supply. For the second cointegrating vector we find industrial production to be negatively influenced by the consumer price index and a long term interest rate. These contrasting results may be due to the slump in the Japanese economy during the 1990s and consequent liquidity trap.