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Credit Conditions and Stock Return Predictability

We analyze U.S. stock return predictability using a measure of credit standards (Standards) derived from the Federal Reserve Board's Senior Loan Officer Opinion Survey on Bank Lending Practices. Standards is a strong predictor of stock returns at a business cycle frequency, especially in the post-1990 data period. Empirically, a tightening of Standards predicts lower future stock returns. Standards performs well both in-sample and out-of-sample and is robust to a host of consistency checks. Standards captures stock return predictability at a business cycle frequency and is driven primarily by the ability of Standards to predict cash flow news.