Over the years, I have seen a number of experts focus heavily on a single or key factor that may influence an economy or market outcome. For example, gross domestic product (GDP) growth receives immense prominence and discussion in the media. While I am not dismissing its importance, GDP is a broad aggregate comprised of many things. Typically, some parts are growing fast and some are shrinking, regardless of the aggregate’s level. Recall that the simplified equation of GDP is the sum of a country’s consumption, investments, government spending and net exports.
Needless to say, despite the attention and focus, the opportunity to generate returns in equities is not especially dependent on high levels of aggregate GDP growth. In fact, the emergence of iconic American companies like Google and Apple did not occur in a period of fast-growth U.S. aggregate output. Studies looking at the relationship between GDP and overall stock market returns, over long periods, generally have found that real stock market returns and per capita GDP are not correlated.1 In other words, countries with high growth rates do not necessarily offer better equity investment returns than ones with slower growth rates, except perhaps in cases where valuations are quite low.
Some countries exhibiting fast GDP growth have shown a persistent history of problems with corporate governance, shareholder rights and ill-defined contract law. Often this has a depressing effect on return structures. China, despite having made strides, comes to mind. Despite extremely fast GDP growth and the success of some outstanding companies, the Shanghai Composite Index today is little changed from its 2000 levels (in local currency terms). By contrast, despite a much slower level of GDP growth, you may have been far better off investing in, dare I say, European stocks.
There is no single, key factor to analyze when seeking equity returns. A number of things matter. We prefer to focus on the quality of the company, the nature of its business, the capability of management and the price to pay for the security.
1 Ritter, Jay R. “Economic growth and equity returns.” Pacific-Basin Finance Journal 13 (2005): 489-503. Past performance does not guarantee future results.↩
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