Aggregate corporate liquidity and stock returns

Aggregate investment in cash and liquid assets as a share of total corporate investment is negatively related to subsequent U.S. stock market returns between 1947 and 2003. The share of cash in total investment is a more stable predictor of returns than scaled price variables and performs well in out-of-sample predictability tests. Cash investment is a stronger predictor of market returns in years in which external predictability tests. Cash investment is a stronger predictor of market returns in years in which external financing is also high. The results support a theory in which firms in the aggregate actively time security issuance relative to investment needs, taking advantage of a time varying cost of capital.