Economic Growth and Equity Returns
A common concern I hear is “I’m worried about the economy, how should I tailor my investments to match that fear?” so today I’m going explore the link between economic growth and equity returns. Looking at historical returns of equities as compared to the growth of that country’s GDP, we see that the link between the two is quite weak. This trend holds steady across both developed and emerging markets.
For developed markets, when GDP growth was positive, 323 countries had returns greater than 10% whereas 192 countries had returns of less than 10%.
We see a similar pattern for developed markets when GDP growth was negative
Emerging markets showed a similar pattern of the effects of growth or decline had on market returns.
What this leads to is asking if we could accurately predict economic growth over the next year, would it impact how we invest? According to research, the answer is no. Even with perfect foresight, knowing how the economy would perform over the next year would not allow us to create a implementable strategy that that would capture reliable excess returns. This suggests that markets are efficient, and quickly incorporate all known data and expectations about future economic growth making it difficult for investors to take advantage of growth forecasts, even with perfect foresight. While many investors look to economic growth to determine future returns in the market, it’s been shown to be a weak link in the historical data, as returns are more affected by discount rates and investor expectations about future growth. If you have questions about economic impact, comment or send me an email.
All research provided by MSCI.