Business Conditions and Expected Returns on Stocks and Bonds

Expected returns on common stocks and long-term bonds contain a term or maturity premium that has a clear business-cycle pattern (low near peaks, high near troughs). Expected returns also contain a risk premium that is related to longer-term aspects of business conditions. The variation through time in this premium is stronger for low-grade bonds than for high-grade bonds and stronger for stocks than for bonds. The general message is that expected returns are lower when economic conditions are strong and higher when conditions are weak.