Fourth-quarter Economic Growth and Time-varying Expected Returns

We show that fourth-quarter macroeconomic growth rates strongly predict the returns of the aggregate market, small- and large-cap stocks, portfolios sorted on book-to-market and dividend yields, bond returns, and international stock returns, whereas growth rates during the other quarters do not predict returns. Fourth-quarter economic growth rates contain considerably more information about expected returns than standard variables used in the literature, are
robust to the choice of macro variable, and work in-sample, out-of-sample, and in subsamples. To help explain these results, we show that economic growth and growth in consumer confidence are correlated during the fourth quarter, but not during the other quarters: When economic growth is low during the fourth quarter, confidence in the economy is also low such that investors require higher future returns. We discuss rational and behavioral reasons why fourth-quarter economic growth, growth in consumer confidence, and expected returns are related.