The Economy Doesn't Matter

The stock market appears to ebb and flow with the daily news about our fragile economy.  Clearly, the health of our economy greatly affects our lives; yet, counter-intuitively, it has less to do with stock performance than you may think.  "Economic statistics have little if any value in forecasting or modeling stock prices," according to the folks who run the Marketfield mutual fund.

Financial Advisor magazine notes that the recent volatility in the stock market has led some investors to search for economic trends and cycles in an effort to predict how the stock market will perform.  After all, as Morgan Stanley points out, "equities are growth assets, so it seems obvious that equity returns should be linked to GDP [gross domestic product] growth."

Morgan Stanley argues, however, that history shows no correlation between GDP growth and stock performance -- "there is little or no link between returns and economic growth."  The Economist cites a number of academic studies that concur with this proposition. 

Ben Inker, head of asset allocation at the global money management firm Grantham, Mayo, van Otterloo & Co., stated that "investing in those countries with the higher GDP growth rate -- assuming you knew in advance what those growth rates would be -- would have failed over the [last 30 years].  There was a negative relationship between GDP growth and market performance."

Why is this the case?  The Economist suggests one answer may be that investors pile into the stocks of high growth countries, thereby driving up their prices, making subsequent returns disappointing.  In other words, the most important factor for future returns may be the relative value of stocks: Are stocks expensive or are they cheap?  Morgan Stanley posits that stock market valuation may be the best guide to future equity returns over the intermediate term.  Ben Inker claims that "the cheapest five markets outperformed the expensive markets by over three percent a year for 30 years."   

While a growing economy provides great benefits for citizens, the ultimate connection between GDP growth and the stock market is not readily apparent to those who seek easy ways to predict the future.    

Words of Wisdom

The fact that some geniuses were laughed at does not imply that all who are laughed at are geniuses.  They laughed at Columbus, they laughed at Fulton, they laughed at the Wright brothers.  But they also laughed at Bozo the Clown.
-- Carl Sagan