Concerns over slowing economic growth abroad have some investors re-considering their allocation to emerging market stocks. Not surprisingly, fears of poor market returns have been stoked by the media. Headlines such as “Emerging markets are crumbling like BRICs,” “Trouble in Emerging-market Paradise,” and “Adviser Cuts Back on Emerging-Market Stocks” abound.
These warnings strike us as mildly amusing, as it was just a few short years ago investors couldn’t get enough emerging market exposure precisely because of their high rates of economic growth.
Have the tables turned so quickly? Should investors now abandon emerging market stocks in the face of low prospective economic (GDP) growth?
Not so fast. Studies actually show the historical relationship between GDP and stock returns around the globe has been the opposite of what one might expect—on average, low-growth countries have had slightly higher market returns than high-growth countries.
The United States and United Kingdom perhaps provide the starkest example of this. From 1900 to 2009, annual U.S. economic growth was about 1% higher than the U.K.’s. Meanwhile, the United Kingdom was losing its position as the world’s foremost economic, military and financial power. Despite this, the two countries’ stock returns were virtually the same.
Results in emerging markets tell a similar story. From 1988 to 2009, researchers found there was no statistical relationship between a country’s economic growth and its stock returns. (Returns in low-growth countries actually outpaced those of high-growth countries.)
One conclusion we can draw from this may be that a country’s market does a good job of reflecting its economic growth in stock prices. The economic progress experienced by high-growth countries tomorrow is largely reflected in prices today. Gaining an advantage requires more than a good forecast of future growth—it is also necessary to know how much of that growth is a surprise to the market (i.e., not already reflected in prices) and when it will materialize.
In other words, you need tomorrow’s paper in advance. We think investors would be better served to focus on the most reliable sources of investment performance, get diversified and stay disciplined when it seems uncomfortable to do so.
1Davis, Joseph et al. “Investing in emerging markets: Evaluating the allure of rapid economic growth.” Vanguard research paper. April 2010
2 Lee, Marlena. “The Economics of Fiscal Deficits.” Dimensional Fund Advisors. October, 2010