Stock Wealth, Consumption, and Return Predictability

Abstract

The stock wealth-consumption ratio reflects expected stock returns and consumption growth. Because consumption growth is mostly unpredictable, much of the variation in this ratio likely reflects changing expected stock returns. In contrast, isolating expected stock return information from other variables may be difficult (in addition to stock returns, the dividend yield may predict dividend growth, while the consumption-wealth ratio may predict non-stock wealth returns). Empirically, a detrended version of this ratio strongly predicts U.S. and international stock returns. In contrast to other predictive variables, predictability does not deteriorate after 1980 and out-of-sample performance is impressive.