Consumption growth and time-varying expected stock returns

When the consumption growth rate is measured based upon fourth quarter data, it tracks predictable variation in future excess stock returns. Low fourth quarter consumption growth rates predict high future excess stock returns such that expected returns are high at business cycle troughs and low at business cycle peaks. The consumption growth rate loses predictive power when it is measured based upon other quarters. This is consistent with the insight of Jagannathan and Wang [2007. Journal of Finance 62, 1623-1661] that investors tend to review their consumption and investment plans during the end of each calendar year, and at possibly random times in between. The consumption growth rate measured based upon fourth quarter data is a much stronger predictive variable than benchmark predictive variables such as the dividend-price ratio, the term spread, and the default spread.