Finance and Economics Discussion Series: What's Good for GM, Using Auto Industry Stock Returns to Forecast Business Cycles and Test the Q-Theory of Investment

We examine the ability of auto industry stock returns to forecast quarterly changes in the growth rates of real GDP, consumption, and investment. We find that auto stock returns are superior to aggregate stock market returns in predicting growth rates of GDP and various forms of consumption. The superior predictive power of auto returns holds for both in-sample and out-of-sample forecasts and has not declined over time. We then apply a finding in this paper---that market returns have no explanatory power for future output or consumption growth when auto returns are included in the regression---to analyze the causal relation between the stock market and investment. We use auto returns to proxy for forecasts of future fundamentals, allowing market returns to capture the effect of the stock market on investment. We find that aggregate returns forecast equipment investment in the presence of auto returns, providing empirical support for q-theory. Results for structures investment are less convincing.