  At the peak of the tech bubble, only 0.57% of market valuation comes from
dividends in the next year. Taking the ratio of total market value to the value
of one-year dividends, we obtain a valuation-based duration of 175 years. In
contrast, at the height of the global financial crisis, more than 2.2% of
market value is from dividends in the next year, implying a duration of 46
years. What drives valuation duration? We find that market participants have
limited information about cash flow beyond one year. Therefore, an increase in
valuation duration is due to a decrease in the discount rate rather than good
news about long-term growth. Accordingly, valuation duration negatively
predicts annual market return with an out-of-sample R2 of 15%, robustly
outperforming other predictors in the literature. While the price-dividend
ratio reflects the overall valuation level, our valuation-based measure of
duration captures the slope of the valuation term structure. We show that
valuation duration, as a discount rate proxy, is a critical state variable that
augments the price-dividend ratio in spanning the (latent) state space for
stock-market dynamics.
