Launching the Fidelity China Special Situations this week, star fund manager Anthony Bolton claimed China was the place to be, from an investment perspective, over the next 10 years:
“I firmly believe that China is the investment opportunity of the next decade. I have been a regular visitor to China since 2004, when I started meeting and investing in Chinese companies. After spending the last few months in Asia, I have become increasingly excited by the prospect of managing a portfolio investing in the growth potential of China. I plan to relocate to Hong Kong shortly in readiness for the launch.”
But will it?
We ask the question because the Credit Suisse Global Investment Returns Yearbook, which brings together 100 years of data on financial markets returns, suggests otherwise:
Many investors are mistaken in the belief that investing in the stock markets of countries that have achieved higher rates of economic growth will generate superior returns. Markets reflect future as opposed to past growth.
Having crunched the numbers the report’s authors — Elroy Dimson, Paul Marsh and Mike Staunton — have found that while there is a positive correlation between long-term economic growth and stock returns, historic per capita GDP growth has a negative correlation with both stock returns and dividend growth:
In 2009, stock markets rallied. Should investors now focus on countries that still hope for recovery, or on those that are experiencing high economic growth? This is the old value-versus-growth dilemma, but on a global scale. Looking at 83 countries over 110 years, we find no evidence that investing in growth economies produced superior returns. However, we do find that stock markets incorporate predictions of future economic growth. When markets recover, economies tend to follow.
That’s right, they can find no evidence that investing in growth economies produced superior returns. If anything, the authors reckon stock market moves are a much better indicator of future GDP growth.
Here are their workings:
The conventional view is that, over the long run, corporate earnings will constitute a roughly constant share of national income, and so dividends ought to grow at a similar rate to the overall economy. This suggests that fast-growing economies will experience higher growth in real dividends, and hence higher stock returns. Consistent with this, the 19 Yearbook countries had a positive correlation (0.41) between their 110-year real growth rate for overall GDP and their annualized real equity returns.
However, growth in GDP has two components: growth in per capita GDP and population increases.
While many European countries, such as the UK, France, Belgium, and Ireland, experienced modest (50%–60%) population growth between 1900 and 2009, the New World grew much faster. The US population expanded by 308%, and the increase was even larger in Australia (479%), New Zealand (423%), Canada (524%), and South Africa (953%). In common with other researchers, when making long run economic growth comparisons, we therefore focus on changes in GDP per capita. This controls for population growth thus providing a more direct measure of growth in prosperity.
Figure 2 ranks the real equity return of the 19 Yearbook countries over the period 1900–2009, from lowest to highest. It shows that there is a high correlation (0.87) between real equity returns and real dividend growth across the 19 countries. However, the claim that real dividends grow at the same rate as real GDP is clearly incorrect. Real dividend growth has lagged behind real GDP per capita growth in all but one country, averaging just –0.1%, and the correlation between the two is –0.30. Even more importantly, Figure 2 shows that the supposed association between long-run real growth in GDP per capita and real equity returns is simply not there (the correlation is –0.23).
The authors say there are several possible explanations for these findings. For example, the growth of listed companies contributes only part of a nation’s increase in GDP:
In entrepreneurial countries, new private enterprises contribute to GDP growth but not to the dividends of public companies. There is thus a gap between long-term economic growth and dividend and earnings growth. It also helps explain why the relationship between GDP growth and stock returns is so noisy.
Moreover, the largest companies listed on most national markets are multinationals whose profits dependent on worldwide, rather than domestic economic growth.
Whatever the explanation the authors says the absence of a clear-cut relationship between economic growth and stock returns should give investors pause for thought. Particularly, we would add, anyone looking to back Bolton’s £630m flotation.
Although economic growth should never be ignored, obviously:
But at the same time, this finding should emphatically not be interpreted as evidence that economic growth is irrelevant. The prosperity of companies, and the investors who own them, will clearly, at any point in time, depend on the state of both national economies and the global economy.
Related links:
Anthony Bolton can you hear me? – The Long Room
Does rapid growth lead to high returns? – FT Alphaville