Why Are Aggregate Investing Activities Negatively Associated with Future Market Returns? The Role of Intangible Investments

Abstract

We reexamine the competing explanations for the negative association between aggregate investment and future market returns. We find that the rational explanation, based on increased investment following reductions in discount rates, appears incomplete. Instead, we find strong evidence supporting the behavioral explanation based on the underperformance of speculative investments. Specifically, the negative association between investments and future returns is concentrated in aggregate intangible investments (especially goodwill), which are positively related to contemporaneous market sentiment. In addition, the negative association is stronger in more recent periods with more M&A activity and purchase price accounting, indicating that the negative association between aggregate investment and future market returns is largely explained by a behavioral explanation based on speculative M&A activities.

Keywords: Aggregate Investment; Tangibles; Intangibles; Rational Versus Behavioral; Future Returns

JEL Classification: M40, E03