Investor sentiment has dimmed markedly since 2021 began, with burgeoning optimism over vaccines and reopening giving way to dread of the Delta variant and its associated public policy and economic implications. Economic expectations have downshifted from a new “Roaring Twenties” to sluggish growth, and many pundits argue stocks will feel a similar malaise as a result. Yet in Fisher Investments’ view, a look back at economic and market history shows slow growth can be a fine backdrop for stocks.
Since US GDP data begin in 1930, the average annual growth rate is 3.2%. [i] That figure is inflation-adjusted and includes all years with recessions as well as expansions. During the full calendar years in those expansionary periods, the annual growth rate lagged its long-term average 25 times. The S&P 500’s average return in those 25 years? A nice 10.8%, just above the index’s 10.2% annualized return since good data begin in 1925. [ii] Returns in those 25 years were positive 19 times, a 76.0% success rate. [iii] That exceeds the S&P 500’s frequency of positive calendar-year returns since 1925, which is 73.7%. [iv]
Most of the 21st century to date has featured slow growth, which Fisher Investments’ analysts think has a few explanations—a big one being that the larger an economy grows, the harder it is to generate fast percentage growth rates even if, in dollar terms, output is growing by a larger amount. That is simple math—the larger the denominator, the smaller the quotient. Stocks haven’t minded this at all. In the economic expansion that ran from July 2009 through January 2020, calendar-year GDP growth was below average in every single year. Yet that expansion was history’s longest, and it accompanied history’s longest bull market. Returns during that bull market, which ran from March 9, 2009 through February 12, 2020, were an astounding 527.8%. [v] If slow growth brought us the longest, biggest bull market on record, then we just don’t see much logic behind the argument that it must be so dreary now.
When you consider how markets work and what GDP really measures, in Fisher Investments’ view, stocks’ tendency not to get hung up on slow growth shouldn’t surprise. Simply, stocks aren’t the economy, and the economy isn’t GDP. The stock market is the value of all publicly traded companies, and owning stocks means owning shares in their future earnings. Those earnings depend on economic factors as well as the political backdrop (which can affect taxes, property rights and other items that affect an investment’s long-term profitability). The broader economy includes all businesses—publicly traded as well as privately owned businesses, self-employed people and kitchen-table enterprises (e.g., craft sales). A lot of that shows up in GDP, but not all of it, as the statistical methodology hasn’t quite kept up with new ways of engaging in commerce. Etsy’s advent, for example, was a big obstacle for record keepers. GDP accounting removes spending on imports—which represent a large slice of publicly traded companies’ sales. It also counts all government spending and investment as positive, without considering whether these outlays are optimal or the possibility that they displace private economic activity. So while GDP is very useful as a measure of the flow of economic activity, Fisher Investments doesn’t think it is accurate to view it as synonymous with “the economy.”
Stocks understand all of this, even if the vast majority of people get hung up on headlines and semantics. They are also forward-looking, discounting widely known information and expectations efficiently. Therefore, a pivotal driver for returns is the degree to which reality exceeds expectations. If significantly slower growth took everyone by surprise, causing earnings to miss expectations badly, that could be a headwind for markets. It would suggest sentiment had become out of touch with reality, which would probably weigh on returns as people adjusted accordingly. But if slow growth isn’t a surprise—or slowish growth rates beat exceedingly dim expectations—then it can be neutral or even positive for markets.
Overall, therefore, Fisher Investments views the downshift in economic expectations as positive. It keeps sentiment in check, delaying the onset of the euphoria that typically accompanies stock market peaks. It should also create a lower bar for reality to clear, increasing the room for positive surprise. If reality beats low expectations, it should help stocks climb up bull markets’ proverbial wall of worry.
Investing in stock markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance is no guarantee of future returns. International currency fluctuations may result in a higher or lower investment return. This document constitutes the general views of Fisher Investments and should not be regarded as personalized investment or tax advice or as a representation of its performance or that of its clients. No assurances are made that Fisher Investments will continue to hold these views, which may change at any time based on new information, analysis or reconsideration. In addition, no assurances are made regarding the accuracy of any forecast made herein. Not all past forecasts have been, nor future forecasts will be, as accurate as any contained herein.
Sources:
[i] Source: St. Louis Federal Reserve, as of 09/22/2021.
[ii] Source: Global Financial Data, as of 09/22/2021. S&P 500 average annualized return, 12/31/1925–12/31/2020 and average returns in 1947, 1956, 1957, 1961, 1967, 1969, 1979, 1981, 1990, 1993, 1995, 2002, 2003, 2006, 2007 and 2010–2019. Recessions based on the National Bureau of Economic Research’s monthly business cycle dates.
[iii] Ibid.
[iv] Ibid.
[v] Source: FactSet, as of 09/22/2021. S&P 500 total return, 03/09/2009–02/12/2020.