By James Saft
Feb 19 Rather than waste time and money making
doubtful predictions about economic growth, you might just do
better by buying stock in countries which have recently had hard
A new study finds a rather puzzling outperformance of
equities in countries which, if you looked at the economic rates
of growth, would appear to be struggling.
This adds to earlier findings by the authors, Elroy Dimson,
Paul March and Mike Staunton of the London Business School,
which found a lack of correlation between economic growth and
That study found a negative correlation, of -0.39, between
per capita GDP growth and returns in a study of 21 countries
between 1900 and 2013. In other words, stocks from the
lower-growth economies tended to outperform the higher-growth
ones. Shift the analysis to aggregate GDP growth, rather than
per-capita, and you get a rather weak positive correlation of
But what happens if you put this into practice?
"There is no evidence of outperformance by economies that
have had high growth in the past," according to the authors, who
carried out the new research as part of an annual review of
investment returns by Credit Suisse. (here)
"Over the period covered by this exhibit, the total return
from buying stocks in low-growth countries in fact surpassed the
return from buying stocks in the high-growth economies."
For the purposes of the study the authors looked at returns
between 1972 and 2013 for 85 countries. Divide that universe
into five parts ranked by aggregate economic growth over the
preceding five years and you get a striking outperformance among
the basket cases. The bottom fifth produced annualized returns
of nearly 25 percent, as compared to just 14.5 percent from the
top fifth. The middle three cohorts are tightly grouped between
14.4 percent and 16.5 percent.
While I might suggest, in something approaching earnestness,
that you fire your economists based on these results, the study
did look at how you would do if you could accurately forecast
future economic growth over the coming five years. Get that
right and there is a massive difference in returns, ranging from
just 4.2 percent for the bottom fifth to 28.8 percent annually
for the top growing fifth.
But to capture those returns you'll need to get your
predicting correct, putting the right countries into the right
baskets. That, as we have seen time and again, is hard to do.
GROWTH VS RETURNS
So why is there a weak to negative correlation between
growth and investor returns?
For one thing all economic growth does not flow to
investors. It is particularly true that growth creates a need
for new capital, which in turn leads to the issuing of shares
and the dilution of the equity portion belonging to existing
Growth also usually implies the application of new
technology, which itself can tend to make existing investment,
sunk costs, return less.
Amazon is a good illustration of this at the
company level. Though it has grown at a tremendous rate, Amazon
has never recorded a profit because its business model requires
it to make new and ever larger investments in technology. That's
driven Amazon stock prices higher, at least so far, but
suppressed those of its competitors.
William Bernstein, of investment advisory firm Efficient
Frontier Advisors, has described what he called the "Paradox of
Wealth," a tendency for economic growth to give rise to low
Under this theory, as economies grow, returns tend to
suffer, in part because the investment in technology rises as a
share of GDP. That costs money, leads to dilution of
shareholders and suppresses returns.
Dimson, March and Staunton make more conventional arguments,
noting that equity prices as they are today factor in
anticipated changes in business conditions.
They also note that when you buy shares in a company in an
improving economy, you are buying an asset that is theoretically
becoming less risky. All else being equal, you should get a
lower return for taking on less risk.
It also strikes me that the competition to invest in "hot"
markets with high levels of growth may cause equity owners to
lose out on a portion of the fruit of their investment that they
can capture in more staid, slow-growing developed economies.
Think of all the foreign companies which have plowed money
into China in hopes of cashing in on its former double-digit
growth. A lot of people got rich, but perhaps a higher
percentage of them were intermediaries rather than shareholders.
Of course this may all simply be a value investment story.
Buy that which is unpopular, unglamorous and beaten down and you
are usually well on your way to outperforming.