Be Fearful When Households are Greedy: The Household Equity Share and Expected Market Returns

Abstract

We empirically document that the “dumb money” effect exists for the aggregate stock market. We define the “Household Equity Share” (HEShare), the share of household equity and fixed income assets allocated to equities. HEShare negatively forecasts excess returns on the aggregate US stock market, both univariately and after controlling for past changes in equity prices and common market return forecasters. The non-household sector’s equity share does not forecast returns, ruling out economy-wide explanations for HEShare’s return predictability. At times, HEShare predicts negative mean excess returns on the market, suggesting that behavioral factors explain our findings.