In this video you will learn about the impact of economic growth on stock prices.
Robin Powell: Hello again. We’re often told the countries to invest in are those forecast to produce the highest rates of economic growth. But is it actually true? Perhaps surprisingly, the academics who’ve studied the evidence - including Professor Elroy Dimson and his colleagues at London Business School - say it’s not.
Elroy Dimson: When we wrote our book, one of the things that we noticed, was, if you looked at the cross-section of countries over more than a century, the ones which had had the highest economic growth actually had somewhat inferior stock market performance. That’s a puzzle.
Robin Powell: In his study, "Is Economic Growth Good for Investors?", Jay Ritter examined data from 15 emerging markets between 1988 and 2011 and found there was actually a negative correlation between growth and stock prices. In China, for example, growth averaged about 9%. But stock returns averaged -5.5%. For Professor Dimson, the crux of the issue is dilution. In other words, the benefits of economic growth are diluted between several different parties. The investor might not benefit at all.
Elroy Dimson: It can be individual entrepreneurs or creating businesses that had value to the economy. It could be people who have jobs, who are getting better compensated for doing that work. It could be the governance. It could be a country which is engaging in public works. Or it could be the corporate sector that's raising funds, issuing shares. So, those are not automatically a benefit to current investors, those may provide a benefit to future investors who buy shares in a company. So it’s a more settled, more nuanced issue than it appears at first sight.
Robin Powell: Another reason why investors are so often disappointed by returns from high-growth economies is simple market efficiency. In other words, projected growth rates are already incorporated into prices.
Elroy Dimson: Investors operate in general internationally, they will be willing to pay more office shares in a high growth scenario than shares in a low growth scenario. So the investment performance that they can gain for investing in a growing economy will not be any higher than you’d expect as a fair award for their investment.
Robin Powell: So, next time you read or hear that such and such a country is tipped to enjoy stellar economic growth, don’t be tempted to pile in. Having a balanced portfolio that’s globally diversified is always the best policy. Goodbye.