Real investment and stock prices in the USA

Purpose – The purpose of this paper is to re‐examine the relationship between real investment and stock prices for the USA for 1960‐2005 in view of distinct economic regimes during the 40‐year period. Design/methodology/approach – The paper employs simple models of investment, checks for cointegration, and applies the value at risk (VAR) methodology. Findings – First, it was found that during the 1960‐1990 period investment and the stock market exhibited a good relationship and shared a common stochastic trend. Second, during the 1990‐2005 period this relationship broke down. Finally, extending the model to include the long‐term interest rate did not produce significant impacts on or feedbacks from and to either variable. It is concluded that the 1990‐2005 period has been distinct from the previous periods in that the stock market did not always abide by the fundamentals such as interest rates and/or investment expenditures. It is thus concluded that the high stock market growth rates of the 1990s have adversely impacted real investment expenditures. Practical implications – Lack of influence of the real long‐term interest rate on either the investment of the stock price equations for the 1990‐2005 period. This implies that both investment and the stock market did not “take into account” a fundamental variable, the discount rate, instead they had a run on their own (especially the stock market). Originality/value – The value of the paper is in showing that interest rates and investment expenditures do not always move as economic theory predicts or that economic fundamentals do not always rule.