Conventional wisdom among investors today is that emerging markets represent a potentially lucrative opportunity for equity growth compared to developed markets.
The argument is that because they did not participate in the excessive debt binge of the 1990s and 2000s, emerging market economies are poised to grow faster than those of developed countries like the U.S.
While this is likely true, what does it tell us about the potential stock-market performance in those countries? In short, not much.
Ben Inker of GMO, a global investment management firm, compared stock-market returns to gross domestic product (GDP) growth across numerous countries since 1900 and found no correlation between the two (see chart, right).
The coefficient of determination (R2 in the chart) is 0.13, meaning that there is little to no relationship between GDP growth and stock-market performance across all the countries indicated. Inker examined developed and emerging countries over the past 30 years and found the same result.
How is this possible? Shouldn’t company earnings grow with GDP and stock prices with earnings? Although aggregate corporate profits and overall market capitalization do in fact correlate with GDP, numerous other factors affect earnings-per-share growth. Because market returns include dividends as well as earnings per share, they could even exceed GDP growth.
While a growing economy, as measured by GDP, certainly portends a healthier business climate, it does not translate necessarily into better returns on equity investments in any particular country. Additional valuation methods should be considered before making investment decisions.
Los Altos resident Artie Green is a Certified Financial Planner with Cognizant Wealth Advisors. For more information, call 209-4062.