Stock Return Predictability in South Africa: An Alternative Approach

There is considerable debate internationally as to whether share returns are predictable. The limited evidence in South Africa (Gupta and Modise, 2012a, b and 2013) reveals that valuation ratios have no forecasting power but the Treasury bill rate, term spread and money supply have been found to be able to predict share returns at a relatively short horizon. In this study, the consumption aggregate wealth ratio of Lettau and Ludvigson (2001) is applied to South African share returns to assess its forecasting power using in-sample tests over both short and long horizons. The forecasting power of this composite variable is compared to a number of traditional variables. Similarly to the developed market evidence, the results indicate that the consumption aggregate wealth ratio is a significant predictor of returns and combined with the term spread, can explain a substantial component of the variation in future share returns. The implications of these findings for practitioners and policy makers are discussed.