The US and eurozone recently reported second quarter GDP growth that fell short of expectations with both posting 1.2% growth rates. The results and other economic reports have led to economists reducing their expectations for growth over the second half of the year. Given the weak recent growth by historical standards and meager future expectations, does this mean that equities are going to see weak performance over the near term?
Dimensional Fund Advisors took a look at this question and found that, historically, GDP growth has little bearing on equity market returns. In Exhibit 1 below, the chart shows GDP growth vs. equity market return for a country in a given year. There are quite a few country/year combinations that have decent GDP growth, but have substantially negative equity performance and those with negative GDP with strongly positive equity returns. In developed markets, when GDP growth was positive there were 323 country/year combinations that had over 10% performance and 192 country/year combinations that had -10% performance. The same trends carried over to emerging markets.
They also found, even with perfect foresight of GDP growth across markets, there is little evidence that the information would have helped. They compared the performance of equity markets in countries that experienced high growth with those that experienced low growth in developed and emerging markets as defined as above or below the median economic growth rate. They found that investing in high growth countries did not deliver reliable excess returns. In fact, the developed markets actually had superior equity market performance from the low growth countries.
While many investors believe that strong GDP growth is needed to see strong equity market returns, the historical data shows that this is not the case. Even if we continue to see slow growth in the US and abroad, how various equity markets perform is anyone’s guess. Thus, we recommend you remain steadfast with your target asset allocations to US and international equity markets and to ensure you are positioned to benefit from equities long term expected return.
Index Performance July YTD Trl 1 Yr
US Stock (Russell 3000) 3.97% 7.74% 4.44%
Foreign Stock (FTSE AW ex US) 5.04% 4.29% -4.66%
Total US Bond Mkt. (BarCap Aggregate) 0.63% 5.98% 5.94%
Short US Gov. Bonds (BarCap Gov 1-5 Yr) -0.04% 2.31% 2.16%
Municipal Bonds (BarCap 1-10yr Muni) 0.22% 2.92% 4.57%
Cash (ML 3Month T-Bill) 0.03% 0.17% 0.22%
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