Classic Bernstein 11 — Stocks, Economies and Populations

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Classic Bernstein 11 — Stocks, Economies and Populations

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PREFACE: This is the eleventh in a series of posts highlighting the classic investing insights of William Bernstein from the 1990s and early 2000s. Many new Bogleheads have never been exposed to his early writings — and while the data sets used may seem antiquated, his portfolio concepts and novel analyses are still helpful to investors today, new and old alike.

Previous topics in the series: 1-Asset Allocation & Time Horizon, 2-Choosing Portfolio Bond Duration, 3-Diversifying Portfolio Equities, 4-Stocks Always Beat Bonds?, 5-What’s a Thing Worth?, 6-The Value Premium & Inflation, 7-The Great Fund Fee Mystery, 8-Is Credit Risk Ever Worth Taking?, 9-The Stock Returns Fairy, Exposed, 10-Economic Growth and Stock Dilution
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In the last series post, Mr. Bernstein followed the bread crumbs from economic growth to the rise in stock prices, but only for the U.S. market. In this analysis, he expands his scope to include 31 countries worldwide, both developed and emerging, each with at least a 35-year history of stock returns (all to 1996). His focus here is on the relationship between stock returns and three important variables — gross GDP, per-capita GDP and population.

GDP and Population Growth. To many investors, it seem obvious that, as a nation’s population and GDP grows, so should its stock prices; there ought to be a direct positive relationship. Unfortunately, there is not. Below, Mr. Bernstein plots stock-price growth versus GDP growth (chart at left) and population growth (chart at right) for the 31 nations studied. In both cases, there is a negative relationship between the two. In short, GDP and population growth appear to be bad for stock prices.
  • Image
    Note: Stock returns are price only, without dividends, and inflation-adjusted.
    Source: William Bernstein, Efficient Frontier, 4/02
Per-Capita GDP Growth. The mystery of the apparent irrelevancy of GDP growth to stock prices is solved when Mr. Bernstein regresses stock-price growth against both population and GDP growth simultaneously — that is, per-capita GDP growth (chart at left below). Per-capita GDP growth shows a fairly strong positive relationship to stock prices. To capture even more of the price return, Mr. Bernstein subtracts population growth from per-capita GDP growth (chart at right), and this simple metric explains fully 55% of national equity returns.
“Leakage” Between GDP Growth and Stock Prices. Finally, Mr. Bernstein examines the leakage between the growth of GDP and the growth of stock prices. For many nations, the amount of GDP growth that escapes before arriving in the hands of shareholders is huge. In this study period, for example, GDP in Pakistan grew at annual rate of 5.7% while stock prices fell at annual rate of 1.8%! This leakage is a good measure of property and shareholder rights and its relationship to population growth appears to be quite strong (chart below).
What conclusions does Mr. Bernstein draw from this brief study?
  • a) The growth of a nation's GDP is good for stock prices only when it comes from increases in individual productivity, as measured by per-capita GDP growth. It's bad for stock prices when caused predominately by population growth alone.

    b) It’s unlikely that a nation's population growth itself is the cause of poor stock returns, but rather an indicator of underlying social and cultural conditions that attend high birth rates and disrupt corporate profits, e.g., intrusive governments with little respect for private property rights, dis-functional capital markets, etc.

    c) Raw economics alone can only explain a small part of national equity returns. Factors well outside the ken of financial economics are far more important and likely less predictable.
Thoughts?
Last edited by SimpleGift on Wed Jun 29, 2016 4:41 pm, edited 2 times in total.
qwertyjazz
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Re: Classic Bernstein 11 — Stocks, Economies and Populations

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Fascinating thank you
Has the amount of leakage been graphed against national corruption scales or free market scales over time? (Like the corruption perception index or its ilk)
Thank you
QJ
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Re: Classic Bernstein 11 — Stocks, Economies and Populations

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Fifteen years on from Mr. Bernstein’s study, it’s interesting to look at the emerging economies of Africa in the context of his analysis. Over the past 10 years, the GDP of the 11 largest sub-Saharan countries has increased 51% — over twice the world’s expansion of 23%. However, their GDP growth per-capita has hardly risen at all and has lagged far behind the emerging economies of Latin America and East Asia (chart below).
Of note, some now write that the African nations may never transition from agrarian to manufacturing economies at all — and that China will likely be the last country to follow the path of industrialization. Why? Although the amount of physical stuff we humans make keeps expanding, manufacturing has become so productive that it’s now a shrinking percentage of the global economy. Since it’s so cheap to make all the stuff we need today, manufacturing will soon become just a niche economic activity — and no longer an available pathway for a nation to grow its per-capita GDP.

Beware, those equity investors interested in the high-growth, emerging markets of Africa.
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Re: Classic Bernstein 11 — Stocks, Economies and Populations

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qwertyjazz wrote:Has the amount of leakage been graphed against national corruption scales or free market scales over time?
There are studies around this question, though I couldn't find any that looked at "leakage" vs. corruption specifically. However, Morningstar did an intriguing analysis a few years ago that regressed the stock performance ranks of 21 developed nations over the past 20 years (1993-2013) versus their perceived corruption, as ranked by Transparency International:
  • Image
    Note: In each case, 1 is the best rank, with the least corruption and highest stock returns.
    Source: Morningstar
These results appear to confirm that cultural honesty has generally paid off for stock investors.
Last edited by SimpleGift on Wed Jun 29, 2016 5:53 pm, edited 1 time in total.
qwertyjazz
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Re: Classic Bernstein 11 — Stocks, Economies and Populations

Post by qwertyjazz »

Fascinating thank you
G.E. Box "All models are wrong, but some are useful."
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Re: Classic Bernstein 11 — Stocks, Economies and Populations

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The complete list of Simplegift's series is now in the wiki: Classic Bernstein
Wiki To some, the glass is half full. To others, the glass is half empty. To an engineer, it's twice the size it needs to be.
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