In a recent note to clients, JPMorgan looked at the relationship between economic growth and long-term equity returns, with a focus on developed and emerging markets.
In developed markets, JPMorgan found a clear correlation between economic growth and equity returns: a 1% increase in long-term real growth is associated with an average 3% increase in equity returns.
This support comes primarily from higher earnings growth, with additional contributions from increased valuations and currency appreciation.
“JP Morgan says about half of the return impact of higher growth in the Saudi stock market comes from higher earnings growth. Just under half comes from higher valuations. The rest comes from a stronger currency.”
But emerging markets tell a different story. Here, the link between economic growth and stock performance is much weaker. JPMorgan points out that many emerging market stocks are not as closely tied to their domestic economies as those in developed markets.
For example, equity-market capitalization in emerging markets often constitutes only a small fraction of GDP, compared to a much larger share in developed markets. As a result, JPMorgan research finds “no relationship between expected growth and actual returns” in emerging markets, challenging the assumption that faster-growing economies should generate better equity-market returns.
The report also addresses the practical challenges of using economic growth as a proxy for stock returns. Long-term growth is notoriously difficult to forecast, and JPMorgan notes that there is often a large gap between projected growth and actual returns.
The report confirms, “We see no relationship between expected growth and actual returns. Actual returns also bear no relation to growth in the recent past.”
However, the bank suggests that investors with strong convictions about a country’s growth prospects may still consider incorporating these views into their investment strategies, albeit with an understanding of the risks involved.
JPMorgan’s analysis confirms that while economic growth can be a useful indicator in developed markets, it is far from a foolproof predictor of stock performance, especially in emerging markets.
The advice for investors is to approach growth expectations with caution and pay attention to the broader factors that drive market returns.
“Given the difficulties of forecasting long-term growth, the results suggest that it is still reasonable for an investor to incorporate any strong views on growth or differences in growth into their asset allocation process.”