On the cross section of conditionally expected stock returns

In this paper, we use macrovariables advocated by recent authors to make out-of-sample forecast for returns on individual stocks and then sort stocks equally into ten portfolios on this proxy of conditionally expected returns. The average returns increase monotonically from the first decile (stocks with the lowest expected returns) to the tenth decile (stocks with the highest expected returns), and the difference between the tenth and first deciles is a significant 4.8 percent per year. While these portfolios pose a challenge to the CAPM, they appear to be explained by Carhart's (1997) four-factor model. Our results indicate that the CAPM anomalies might not be attributed entirely to data snooping or irrational pricing because they are correlated with systematic movements of the macrovariables that forecast stock market returns.