Global GDP Growth --> World Stock Returns, 1970-2017

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SimpleGift
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Global GDP Growth --> World Stock Returns, 1970-2017

Post by SimpleGift » Tue Mar 20, 2018 1:06 pm

It's become axiomatic that economic growth rates in individual countries have no correlation with stock returns in their home equity markets. There's just been no historical relationship between the two. However, the correlation between GDP growth rates and stock returns for the world as a whole (a closed system) is better established and not so well known. In this post, we revisit this topic and include updated data through the end of 2017.

Does Global GDP Growth Drive World Stock Returns? From 1970 onward, we now have nearly five decades (48 years) of data from which to compare global GDP growth rates with returns of the MSCI World Index. Just eyeballing the chart below, where stock returns are plotted against year-ahead GDP growth (since stock markets are forward looking), the relationship appears fairly strong.
  • Image
    NOTE: Stock returns are compared with year-ahead real GDP growth rates.
    Sources: GDP Growth from World Bank; Stock Returns from MSCI World (1970-1998), MSCI ACWI (1999-2017).
Looking in more detail, the two charts below show year-ahead GDP growth rates regressed against annual stock returns for the two 24-year periods from 1970-1993 and 1994-2017. The relationship has been positive in both periods — but with increasing globalization and more stable growth, correlations rose dramatically between the two periods, with R^2 climbing from 0.28 to 0.64. Surprisingly, global GDP growth rates have explained nearly two-thirds of the returns of world cap-weighted stocks since 1994!
  • Image

The Current Outlook for Global Growth? In encouraging news for global stock investors (whatever your allocation), the IMF has lately been upgrading its global growth forecasts for the first time in years (chart below). The Fund describes world growth today as robust and broad-based, with "some 120 economies, accounting for three-quarters of world GDP, seeing a pickup in growth."
  • Image
    NOTE: Forecast lines run left-to-right, earliest forecast to latest.
    Source: AdvisorVoice
Thoughts on any of this?
Cordially, Todd

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galeno
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Re: Global GDP Growth --> World Stock Returns, 1970-2017

Post by galeno » Tue Mar 20, 2018 1:19 pm

We use ONE FTSE all world equity ETF in an attempt to capture all this world economic growth.

Sometimes the USA runs ahead. Sometimes it's developed non-USA. And sometimes it's the EM economies and or stock markets.
AA = 40/55/5. Expected CAGR = 3.8%. GSD (5y) = 6.2%. USD inflation (10 y) = 1.8%. AWR = 3.0%. TER = 0.4%. Port Yield = 2.0%. Term = 35 yr. FI Duration = 6.2 yr. Portfolio survival probability = 100%.

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alpine_boglehead
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Re: Global GDP Growth --> World Stock Returns, 1970-2017

Post by alpine_boglehead » Tue Mar 20, 2018 1:24 pm

Very interesting, thanks for posting. Somehow, the GDP stock market relationship isn't too surprising.

I've always wondered why there should be such a low (no) correlation between GDP and stock market returns for countries, when a good portion of the companies' growth comes from GDP growth, and presumably the stock market is oriented towards the expected future (which is brighter when the GDP grows, right?).

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SimpleGift
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Re: Global GDP Growth --> World Stock Returns, 1970-2017

Post by SimpleGift » Tue Mar 20, 2018 1:36 pm

alpine_boglehead wrote:
Tue Mar 20, 2018 1:24 pm
I've always wondered why there should be such a low (no) correlation between GDP and stock market returns for countries, when a good portion of the companies' growth comes from GDP growth, and presumably the stock market is oriented towards the expected future (which is brighter when the GDP grows, right?).
From what I've read, several factors are behind the historical disconnect between GDP growth and stock returns in individual countries:
  • 1. In most emerging countries, a large portion of economic growth comes from new enterprises and newly-floated stock shares, not the growth of existing coompanies and shares that are included in the country indexes.

    2. Expected rapid economic growth is often built into valuations of existing companies, reducing their future realized returns.

    3. Thus high-growth markets are not necessarily good investments — unless they can be purchased at low valuations.
We've had a few Forum discussions on this topic, see here. Plus, there's an older but good paper from MCSI, found here.
Last edited by SimpleGift on Tue Mar 20, 2018 1:59 pm, edited 1 time in total.
Cordially, Todd

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willthrill81
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Re: Global GDP Growth --> World Stock Returns, 1970-2017

Post by willthrill81 » Tue Mar 20, 2018 1:58 pm

Global GDP growth certainly appears to be a good predictor of world stock returns. But an even stronger predictor of at least U.S. returns (R-square = .86) for a longer period of time (since 1952) is U.S. investors' average stock allocation.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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SimpleGift
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Re: Global GDP Growth --> World Stock Returns, 1970-2017

Post by SimpleGift » Tue Mar 20, 2018 2:40 pm

If interested in more on the relationship between global growth and world stocks returns, this 2016 white paper from Norges Bank (Norway's central bank) is one of the best I've seen: Global Growth and Equity Returns: Discussion Note

Included in this report was an interesting historical analysis using the Dimson-Marsh-Staunton database for the 110-year period from 1901-2011. The study divided global stock returns into non-overlapping periods with high, medium and low GDP growth (chart below).
Both high and medium growth periods had relatively high stock returns. However, the growth-return relationship was not linear — low growth periods produced significantly lower stock returns.
Cordially, Todd

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