In a recent note to clients, JPMorgan delved into the relationship between economic growth and long-term stock returns, with a focus on developed markets (DM) and emerging markets (EM).
In developed markets (DM), JPMorgan finds a clear link between economic growth and stock returns. A 1% increase in long-term real growth is associated with about 3% higher stock returns on average.
This boost comes mainly from higher earnings growth, with additional contributions from higher valuations and currency appreciation.
“About half of the return impact of higher DM growth comes from higher earnings growth,” JPMorgan said. “Just under half comes from higher valuations. The rest comes from currency strengthening.”
Emerging markets, however, tell a different story. Here the link between economic growth and stock performance is much weaker. JPMorgan points out that many emerging market stock markets are not as closely linked to their domestic economies as those in developed markets.
For example, emerging markets’ stock market capitalizations are often only a fraction of GDP, compared to a much larger share in DMs. As a result, JPMorgan’s research finds “no relationship between forecast growth and actual returns” in emerging markets, questioning the assumption that faster-growing economies should deliver better stock market returns.
The report also addresses the practical challenges of using economic growth as a predictor of stock returns. Long-term growth forecasts are notoriously difficult to pin down, and JPMorgan notes that there is often a significant gap between forecast growth and actual returns.
“We see no connection between forecast growth and actual returns. Actual returns are also not related to recent past growth,” the report points out.
Nevertheless, the bank suggests that investors with strong beliefs about a particular country’s growth prospects could still consider incorporating these views into their investment strategies, albeit with an understanding of the risks involved.
JPMorgan’s analysis underlines that while economic growth can be a useful indicator in developed markets, it is far from a guaranteed predictor of stock performance, especially in emerging markets.
The advice for investors is to approach growth forecasts with caution and take into account the broader factors driving market returns.
“Taking into account the difficulties in forecasting long-term growth, the results suggest that it would still be reasonable for an investor to incorporate strong beliefs about growth or growth differentials into their asset allocation process.”
