Growth investments – looking in the right places

June 19, 2014 Categories: Investment Strategy

russell-investments-wire-blog-Growth investments

At the NAPF Investment Conference in March, one of my personal favourite sessions was my colleague Don Ezra’s talk on happiness (see short video below).

graphic-Growth-investments-

Turns out that happiness is not the preserve of the young. Apparently, research shows that, as we get older we gain greater perspective and more contentment. So believe it or not, being young and vigorous is not highly correlated with being happy – who would have thought it?

In just the same way, many investors assume that dynamic economies with rapidly rising GDP must offer the best stock-market returns. Accordingly, investors carefully watch economic indicators to inform their stock-market investment decisions.

Turns out it’s not so simple as that. For example, the average correlation in 19 countries between long-run real growth in Growth Domestic Product (GDP) per capita and real equity return was -0.23, based on data from 1900–2009 . This means that GDP growth per capita and real equity returns tended to move in opposite directions, not together.

There are a few reasons why this might be so.

  • Listed companies contribute only a part of a nation’s increase in GDP—private enterprise or nationalised industry contributes to GDP but not to the dividends of public companies.
  • Multinational firms may have little dependence on the local economy in which they are listed. For example, BP Amoco is listed on the London Stock Exchange, but its success relies little on the fortunes of the UK economy.
  • To the extent that growth feeds through into equity prices, expected growth is factored into the buying price. Good returns happen as expectations for growth increase, not when the growth actually happens.

Economic growth is not irrelevant. In the long term, the prosperity of companies must rely on the prosperity of the world economy in which they operate. But shorter term the mechanism by which economic growth feeds through the equity returns is unclear at best.

So in fact, markets are pretty good at pricing in growth prospects. And that’s why high growth economies do not necessarily outperform developed economies in the short term. It’s not enough to look at economic indicators, you have to look at equity prices too.

10 Second myth buster

Myth
Positive economic growth is a strong indicator of positive equity returns in the region

Reality
The link between economic growth and stock market performance is statistically weak and often perverse in the short term.

Sorca Kelly-Scholte – Managing Director, Client Strategies & Research, EMEA

Sorca Kelly-Scholte

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