It might seem logical to assume markets in countries with the highest economic growth rates would produce the best investment returns.
Sharp increases in gross domestic product (GDP), however, do not automatically translate into bigger market gains. Take China for example: The Wall Street Journal recently reported that between 1993 and 2010, China’s GDP grew by an inflation-adjusted average rate of 9.5%. The Chinese stock market, however, gained just 2.2% per year.
In fact, studies show the historical relationship between GDP and stock returns around the globe has often been the opposite of what one might expect—on average, low-growth countries have had slightly higher market returns than high-growth countries. This was the finding of a recent MSCI Barra research bulletin that compared developed markets from 1958 to 2008. The experience in emerging markets has been the same.
Market expectations may partially explain these surprising results. Expectations in high-growth countries can get overblown, pushing prices to levels that set the market up for disappointment. In contrast, prices in low-growth countries can remain relatively cheap, leaving plenty of room for appreciation when low expectations are even slightly exceeded.
A few other considerations are worth keeping in mind, too, when thinking about the link between GDP growth and market returns. First, the fruits of a country’s economic growth are not enjoyed exclusively by its publicly-traded companies and their shareholders. Workers, governments, private companies, and multinational companies based in other countries also take their share of the benefits. Second, companies must convert economic growth into profits in order to sustain stock prices and drive market returns.
Economic growth can form the foundation for a country’s market advances, but by itself, it is not an indicator of investment returns. Prudent investors look beyond headline GDP figures and invest in globally-diversified portfolios, with country weights based on their relative size within the broader world market.
1 Stein, Peter. “Why Stocks Don’t Always Boom With the Economy.” Wall Street Journal, February 21, 2011.
2 “Is There a Link Between GDP Growth and Equity Returns?” MSCI Barra Research Bulletin, May 2010.