The Role of Consumer Confidence on the Time-Series Association between Prices and Fundamentals

We investigate whether time-series variation in consumer confidence affects the long-run association between prices and accounting based measures of fundamental value (hereafter, fundamentals). We estimate the components of consumer confidence related to expected growth and investor sentiment. We find a significant role for both expected growth and investor sentiment on the time-series association, or co-movement, between prices and fundamentals. We then investigate the ability of fundamentals to forecast shortand long-term aggregate market returns. In the short-term, fundamentals, expected growth and investor sentiment are positively associated with future aggregate market returns. Over longer horizons, expected growth and investor sentiment are negatively associated with future aggregate market returns. The role of investor sentiment is strongest in the more volatile markets observed in recent time periods. Our results are consistent with both the rational incorporation of growth expectations and noise-trader sentiment affecting the pricing of accounting fundamentals.