Explanation

In the Grinold-Kroner model, economic growth primarily impacts equity returns through earnings growth per share. The model decomposes equity returns into three components:

1. Expected income return (dividend yield)
2. Expected nominal earnings growth
3. Expected repricing (P/E ratio changes)

Economic growth drives corporate earnings growth, which directly affects the second component. While dividend yield and P/E repricing also contribute to total returns, earnings growth is the most direct channel through which macroeconomic growth translates into equity market performance.

Key points:

• Economic growth → Corporate revenue and profit growth → Higher earnings per share
• This is more fundamental than dividend policy or valuation changes
• The model shows earnings growth as the primary transmission mechanism from economic growth to equity returns