What Drives Market Return Predictability?

Market return predictability may be driven by time varying discount rates or changing beliefs of cash flow. We use analyst earnings forecast to separate cash flow and discount rate components of returns and distinguish the source of return predictability by a set of predictive variables commonly used in the literature. The overall evidence is consistent with the idea that the predictive variables capture time varying discount rates. Some variables also predict cash flow component of returns, implying that these predictive variables may capture investors' biases in projecting aggregate future cash flows