Although it seems counterintuitive, evidence suggests that there is a negative correlation between economic growth (GDP) in emerging markets and stock market performance, says a recent Morningstar article.
Alex Bryan, Morningstar’s director of passive strategies research (North America) explains that while emerging markets will “likely continue to grow faster than developed markets for the foreseeable future,” these gains might not extend to investors. Using real GDP data from the World Bank and the gross return version of MSCI country indices, Bryan found that across 41 countries (for the period from 1988 to 2015), higher economic growth did not translate into stronger stock market performance.
According to Bryan, the findings should not be terribly surprising. He says that for these two measures to move in step with each other, some lofty assumptions would have to hold true. These include:
- Publicly-traded stock valuations and earnings as a share of GDP would need to remain stable over time;
- Private and public companies would need to grow at the same rate, and there could be no new enterprises or IPOs;
- There could be no dilution from new share issuance;
- All public companies would need to generate the bulk of their revenue and profits from the domestic economy.
Even if aggregate corporate profits grow along with GDP, Bryan argues, “dilution can prevent shareholders from enjoying the benefits of growth” because new entrants to the market will drive much of that growth. “Between the time these new companies are launched and publicly listed,” he says, “their growth dilutes most investors’ ownership interest in the economy.”
To benefit from economic growth, says Bryan, “investors must identify markets that have the potential to exceed expectations.”