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2013 was a great year for investors. Stock markets in all 24 developed countries had positive returns, with Greece being the best gaining 49%.
 
What may be surprising to many investors is that the PIIGS (Portugal, Italy, Ireland, Greece and Spain), which were in financial turmoil during the last few years, were among the top performers in 2013. The BRICs (Brazil, Russia, India, and China), which had strong GDP growth, were among the bottom performers.
 
Chart 1: 2012 GDP Growth Rate and 2013 Market Return
 

Source: World Economic Outlook Database October 2013, Morningstar Direct January 2014.
 

2013 was a great example to show that GDP growth rate does not predict stock market return.
 
Chart 1 shows the 2012 GDP growth rate and the subsequent year market return for BRICs and PIIGS. The GDP growth percentile rank is the ranking of a country’s GDP growth rate among 45 countries (24 developed countries and 21 emerging markets. See Chart 3.)
 
The 2012 GDP growth rates in Russia, India and China were among the highest 30th percentile but their 2013 market returns all underperformed the median. The 2012 GDP growth rates for PIIGS were all in the bottom quartile but their 2013 market returns outperformed the median. GDP growth rate was negatively correlated to subsequent market return at -0.59 for 2013, contrary to the positive relationship that many investors believe!
 
A closer look at the data over the last 12 years confirms that GDP growth rate has no predictive power.
 
Chart 2 shows the rank correlations between GDP growth rate and subsequent year market return during the time period from 2002 to 2013. For each year, the 45 countries are ranked by GDP growth rate of the current year and by market return of the subsequent year.
 
The correlation between the two rankings is the rank correlation. A correlation of 1 indicates that the GDP growth rate is perfectly correlated with subsequent market return (high GDP growth rate is associated with high market return). A correlation of -1 indicates perfect negative correlation (high GDP growth rate is associated with low market return). A correlation of 0 indicates no relationship between GDP growth rate and market return.
 
What we see is that the correlation alternates between positive and negative throughout the years and there is no consistent pattern. The correlation over the 12-year time period from 2002 to 2013 is very small at 0.12, which indicates that the GDP growth rate does not predict subsequent market return.
 
Chart 2: Rank Correlation Between GDP Growth Rate and Subsequent Year Market Return
 
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Source: World Economic Outlook Database October 2013, Morningstar Direct January 2014.
 
While the positive link between GDP growth and market return may seem intuitive, a number of academic studies show the contrary. Ritter (2005) reported that the cross-country correlation of per capital GDP growth and real stock returns was -0.37 for 16 countries over the 1900 – 2002 period. A study in Credit Suisse Global Investment Returns Yearbook 2010 examined 83 countries over the period 1972 – 2009 and reported that countries in the lowest GDP growth quintile outperformed the highest quintile.
 
Market returns are hard to predict. It is difficult to forecast which country will outperform or underperform in the future. And since global markets have dissimilar return patterns historically, investors should diversify globally to help reduce portfolio risk.
 
Chart 3: Country Returns
 
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Source: Morningstar Direct January 2014
 
Past performance does not guarantee future results and the principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost.
 
International and Emerging markets involve additional risks, including, but not limited to, currency fluctuation, political instability, foreign taxes, and different methods of accounting and financial reporting. As a result, they may not be suitable investment options for everyone.
 
Diversification neither assures a profit nor guarantees against loss in a declining market.
 
IRN R 14-078 (Exp 2/16)

 


1Source: World Economic Outlook Database October 2013.
2Source: Morningstar Direct January 2014.
3Ritter, Jay R., Economic Growth and Equity Returns, Pacific-Basin Finance Journal 13 (2005) 489 – 503.
4Credit Suisse Global Investment Returns Yearbook 2010, p 17.