Why the Long Term Growth of the Economy is Not Relevant to Investing

An economist is an expert who will know tomorrow why the things he predicted yesterday didn’t happen today. – Laurence J. Peter

Our last article explained why the economy is not relevant to investing – short term. If you want to forecast the stock market this year or next year, the economy is essentially irrelevant – because the stock market forecasts the economy, not the other way around.

More surprising for investors, however, is that even the long term growth of the economy is not relevant to investing!

Most investors mistakenly believe that, over the long run, stock prices rise because of growth in profits brought on by the economy. Specifically, the belief is that the long run stock market growth = economic growth + change in multiple (normally expressed as P/E, or Price/Earnings multiple).

This is widely believed, even though it is obviously false when you look at the numbers! The actual stock market growth in most countries is many times the economic growth long term (see chart below).

A related “conventional wisdom” is that countries that have a strong economy will have a strong stock market. This sounds perfectly logical – it’s just not true. In fact, the opposite may be true!

For example, many news stories gloat about the high growth of the economy of China at about 10%/year. This is used to claim that investing in China will be a good investment. Recently, other news stories speculate that the US and Canada may have slower growth for a few years, and this is used to suggest that the stock market returns may also be lower.

However, in-depth studies comparing countries with high growth economies show this does NOT translate to higher stock market growth. In fact, if anything the opposite is true!

The most in-depth study we have seen is in the classic investment book on global stock markets “Triumph of the Optimists”, Dimson, Marsh & Staunton. They analyzed the correlation of GDP growth to the stock market in 17 major countries from 1900-2000 and found:

Correlation of GDP Growth to Stock Market

Time Period Correlation What it Means
1900-2000 -.27 Negative correlation
1950-2000 -.03 No correlation

Note that “negative correlation” means that they tend to move in opposite directions – higher GDP growth generally resulted in lower stock market growth, and vice versa. Higher GDP does NOT mean it is a better place to invest.

Their conclusion:

“Since 1900, low-growth economies have superior stock market performance. Historically, buying into equity markets with a high GDP growth rate has given a return that is below the return of markets with a low GDP growth rate. There is no apparent relationship between equity returns and GDP growth.” – Global Investment Returns Yearbook 2005, Dimson, Marsh and Staunton.

Stock markets vs GDP

Figure:  Higher stock markets generally were in countries with lower GDP growth in their economy. Source: “Triumph of the Optimists”, Dimson, Marsh & Staunton.

In another study, Jeremy Siegel compared GDP growth to stock markets from 1970-97 and came to the same conclusion:

Correlation of GDP Growth to Stock Market

Type of Country Correlation What it Means
17 developed countries -.32 Negative correlation
18 emerging markets -.03 No correlation

Jeremy Siegel also did a 107-year study from 1900-2006 with the same conclusion:

“The results are striking. Real GDP growth is negatively correlated with stock market returns. That is, higher economic growth in individual countries is associated with lower returns to equity investors.” – Jeremy Siegel, Stocks for the Long Run.

Ken Fisher (star fund manager and columnist for Forbes) in his myth-busting book, “The Only Three Questions You Need to Ask” explains:

“A major error investors make in foreign investing – developed countries as well as emerging markets – is assuming a country with a growing GDP must have good stock returns. By the same logic, a flat or negative GDP is often assumed to lead to poor stock returns. This easily debunked Question One myth has been a major cause for investor interest in China over the past few years.”

This myth is popular because people like to have very simple methods of understanding what is going on and because human beings are wired to see correlations whether or not they exist. Economic data is widely covered in the news with many news stories trying to relate it to the stock market. For investors that do not have an in-depth knowledge of stock markets and market history, the economy provides a simple way to talk about the market in broad generalities.

Bottom line: Countries with lower GDP growth generally have better stock markets.

The economy and the stock market are different like “chalk and cheese”. The reasons that slower growing economies generally have higher stock market growth are not fully understood, but here are the most likely reasons:

1. Expectations of the economy are built into prices of stocks:

Jeremy Siegel believes it is because the higher economic growth is built into stock market prices ahead of time and that it is often overly-optimistic. The price investors are willing to pay for a stock or mutual fund includes their expectations for how good an investment it will be. Therefore, investments in countries or sectors that are expected to perform well will tend to be at over-valued – which means their future returns will likely be lower.

2. Companies have many ways to grow profits:

Our opinion is that companies are able to adjust their operations to continue to grow their profits, whether or not the economy is growing strongly. Management is focused on annual targets to grow their profits and can do this in many ways – cost cutting, more efficient systems, new products, new technology, selling unprofitable divisions, buying competitors, gaining customers from competitors, new marketing/advertising programs – or replacing the management. Management is expected to grow profits regardless of the economy.

3.The economy is based on gross and the stock market is 15 times net:

As an accountant and a finance guy, it is easier to see why they are not a proper comparison. The economy is related to the “total output” of the country, which includes the sales or income of companies (and governments, etc.), while the stock market is normally based on a multiple of the profits or bottom line of companies (typically 15 times).

A comparison to your personal budget could be that the economy is like your salary (your gross), while the stock market is like 15 times the money you have saved/invested or have left over at the end of the month (your net).

When you think of them this way, you can see why they may grow completely differently for many reasons. For example, if you get a 10% raise, does that mean you will have 10% more money left over at the end of the month? Maybe/maybe not. If you reduce an expense (pay off a loan or buy a cheaper car), your bottom line soars (especially when you multiply it by 15), even though your salary/income did not change.

This is why the formula is false: stock market growth (15 times net) = economic growth (1 times gross) +/- change in multiple. You can’t compare 1 times gross to 15 times net!

4.The stock market is linked to the total of all shares, not to the average price per share.

Jeremy Siegel also believes that “economic growth influences aggregate earnings and dividends favourably, economic growth does not necessarily increase the growth of per share earnings or dividends. This is because increased growth requires capital expenditures…” (Stocks for the Long Run). He believes that it costs money to support higher growth. This is either borrowed, which lowers profits, or financed by issuing new shares, which lowers the profit per share.

5.The economy and the stock market are like “chalk and cheese”.

Companies and the economy are just different. For example:

  • Ken Fisher, “The Only Three Questions You Need to Ask” explains: “Prices are determined by shifts in supply and demand, which may or may not parallel whether GDP growth is strong, weak, or nonexistent.”
  • Some factors affect them differently. For example, high unemployment is clearly bad for the economy, but is arguably good for companies in the stock market. It means that some consumers are less likely to spend money, but on the upside, it also means that there is an available workforce, less pressure to increase wages, and that they are more likely to keep their best employees.
  • The stock market is not the same companies over time. Obsolete or unprofitable companies are replaced by more profitable, innovative companies, especially in a slower economy.


The economy is not really relevant to stock market investing – short term or long term.

I realize this belief is very ingrained in the thinking of many investors, who may find it difficult to understand the stock market without thinking of the economy. However, a growing body of evidence continually confirms that economic growth is not necessary for good stock market returns – and in fact lower economic growth may promote good stock market returns.

The stock market does what it does – grows significantly long term with 1 or 2 bear markets per decade – generally regardless of what happens in the economy.

If you are an investor, your limited time is best spent on things that are definitely relevant, such as understanding stock market history and researching the quality of your investments. Forecasts and conjecture about the short or long term economic outlook or growth rates for the economy, sector or country may amount to just “market noise” or distraction to be avoided in your investment decisions.

Reader Poll

Since the reasons that slower growing economies tend to have faster growing stock markets is not fully understood, which of the 5 explanations do you believe is correct (or do you still believe that growth of the economy is necessary for the stock market to grow)?

About the Author: Ed Rempel is a Certified Financial Planner (CFP) and Certified Management Accountant (CMA) who built his practice by providing his clients solid, comprehensive financial plans and personal coaching.  If you would like to contact Ed, you can leave a comment in this post, or visit his website EdRempel.com.  You can read his other articles here.

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Ed Rempel

Ed Rempel is a Certified Financial Planner (CFP) and Certified Management Accountant (CMA) who built his practice by providing his clients solid, comprehensive financial plans and personal coaching.

Ed has written numerous articles to educate the public and his clients on his unique insights into strategies that actually work, instead of the “conventional wisdom” common in the financial industry.

Ed has trained more than 200 financial advisors and is considered the Smith Manoeuvre expert in the Toronto area. He has received accolades from Frasier Smith in his book “The Smith Manoeuvre” for customizing this strategy for hundreds of clients. His extensive experience in tax and finance has placed him in high demand. Ed’s team collaborates on each of their clients to help them create financial security and freedom.
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DIY Investor
10 years ago

Interesting. Reinforces to me that we need to think in terms of expectations and side factors. Today the economy is weak with the possibility of a double dip on the horizon. If we’re just looking at GDP then we predict a further drop in the market. But a flat GDP will be “good news” and could push stocks higher in a weak economy. Furthermore, the overall economy is weak causing some good side events. Cash on the sidelines is building, refis are on the rise etc.
Thus, to me it’s not just about going out and thinking about investing in the fastest growing economy.

larry macdonald
10 years ago

Don’t studies showing negative correlation between growth in GDP and stocks (like the ones referred to) usually show the correlation between average annual changes or some other short-term period? That would not seem to prove long-term earnings or economic don’t matter – just that they may not move similarly within those annual or short-term periods.

Perhaps the message in the post is that the long history of the stock market shows investors can’t use the state of the economy to forecast stocks in the short to medium term because the stock market is forward looking and discounts the future.

Michael James
10 years ago

Larry hit the nail on the head. Few people understand the technical meaning of correlation. Two quantities can move in near lock-step as perceived by looking at their charts, but the correlation can be negative. The conclusion that the economy doesn’t matter for long-term investing is completely incorrect.

10 years ago

@Michael & @Larry – totally agree. The author had a similar message in the previous post… not sure why anyone can trust him/her to manage their finances…

there was an interesting philosophical argument on how stock markets perhaps feed the economy… companies raise capital in the stock markets which feeds into the economy as a manufactured product/service provided by the company.

as for the correlation study – perhaps the correlation should be with 12-18 month lagged returns to reflect the discounting… not the same period!

10 years ago

The “economy” means a lot of different things than just GDP growth. Take for example the level of unemployment. Were this metric to remain high for an extended period of time it would have a definite effect on many stocks as consumer demand would be lower resulting in shrinking profits. A prolonged period of deflation (a shrinking economy) would also affect stock prices in general if Japan is any indication. Just my 2cents.

10 years ago

Tom, I agree that economy is bigger than just GDP, but measuring GDP growth gives you a relatively good idea of the strength of a country’s economy. Sure you could factor in unemployment levels, but those often correlate with the GDP growth anyways.
The evidence in this article is pretty convincing. It seems clear that there is no link between GDP growth and the strength of the stock market at any particular moment in time (though as takloo said, there may be a lagging correlation that the studies may or may not have looked for).
Using Japan as an example actually proves the point of the article… between 1900 and 2000 it had the highest GDP growth of any of the countries shown, but stock market returns were barely over 4%. So obviously the thriving economy didn’t help boost stock prices, and now that they’re in deflation, it isn’t going to be a cause for decreasing stock prices either – at least not immediately.

Ed Rempel
10 years ago


Right on. You can’t just invest in a fast growing economy. For instance, right now, there are many articles about problems in the economy (low growth, high unemployment, etc.) and with consumers (high debt), yet at the same time companies are in the best shape they have been in for years.

Dividend yields are above long bond yields for the first time in decades. Balance sheets are strong with cash which normal is about 4% of asset is 50% higher at about 6%.

We also hear many anecdotes from our fund managers about various companies with little or no debt and trading at very low prices.

How can the economy & consumers be in horrible shape while companies are in great shape? Easily.

The stock market is far more complex than the economy, and yet is only one small piece of the economy.


Ed Rempel
10 years ago

Hi Larry, Michael & Takloo,

The last article was about short term correlation – 1 year. It showed there is no correlation, but there is a 33% correlation with a 1-year lag. This is because the stock market tries to predict the economy.

However, a 33% correlation is utterly useless for any type of forecast. Even a coin is better.

Posts following that article understood the lack of short term correlation, but stated there must be a long term correlation.

This article is about long term correlation. The chart shows it. Faster growing economies do not have faster growing stock markets. A variety of studies all seem to have the same conclusion, whether the studies are for 28 years, 100 years or 107 years.

Correlation is mathematically accurate. The human mind plays tricks on people looking at charts sometimes, where they see a correlation that does not exist.

In this case, however, even the chart is clear.


Ed Rempel
10 years ago

Hi Tom,

There is a lot of talk in the news about unemployment. It is an important factor for the economy, but not necessarily for companies. It means they have a large pool of workers and should have less wage pressures.

While we haven’t looked at unemployment specifically related to the stock market, I would assume the slower growing economies had higher unemployment. But that did not hurt the stock market in the countries in the study.

Short term, there would be no correlation. The stock market is considered a leading indicator that tries to predict the economy, while unemployment is considered a lagging indicator that usually rises only long after an economy recovers.

I find all the news articles about a “jobless recovery” funny. Nearly all recoveries are jobless! That is the norm. Companies don’t normally start hiring until they are sure their business is on solid ground again. I guess it sells newspapers and it does affect a lot of people.

For the stock market, a “jobless recovery” sounds like good news.

Japan is a unique situation. Much of the problem with their stock market is because the tried to prop it up after their super-boom. The NIKKEI went from 300 to 40,000 in 10 years, and then has been in slow collapse. It has lost money for 20 years, but the 30-year return is similar to the US and global markets (about 10%/year).

I understand your logic and it makes perfect sense. It is hard to understand why, but the economy does not need to perform well for the stock market to perform well.


Ed Rempel
10 years ago

Hi Larry,

I read your post again and agree with your point. I guess you agree with reason #1. You can’t use the economy to forecast stocks because stocks have already priced in the economic forecast.

Being in the news, you must notice all the daily articles lamenting that the economic problems will mean our portfolios will suffer. It does make for good news stories because it seems so logical and simple. It is much easier than writing more in-depth stories. I noticed your articles tend to be more general interest financial articles that are not usually based on such over-simplified assumptions.

It amazes my how many investors, financial advisors and fund managers spend so much time on the economy, rather than focusing on their portfolio. The conclusion from the studies is that choosing investments based on what is happening in the economy probably won’t produce results.

The interesting part for me is not debating whether or not the correlation is there. It is in trying to understand why not. Once you let go of the believing they are related, you can start to understand more of what works and what doesn’t with the stock market.


Ed Rempel
10 years ago

Hi Everyone,

The score so far is:

Reason #1: 1 (Larry)
Reason #2: 0
Reason #3: 0
Reason #4: 0
Reason #5: 0
Still believe in the correlation: 4


10 years ago

The thing is that markets are quite efficient. Lets assume we have two companies. Company A has a expected growth rate of 0% and company B of 10% per year. Because markets are efficient this expectations are already priced into to the stock price e.g. lower P/E ratio for company A.

Lets assume both companies met their expectations after 1 year. Company A grow 0% while company B grew 10%. It is likely that stock prices performed equally well for the two companies, because both companies met what the market expected.

Lets assume Company A beat expectations and achieved a growth rate of 3% and company B missed expectations and had a growth rate of only 7%. Even while the growth rate of company B is higher as compared to company A it is likely that the stock of company A performed better.

It is not the actual growth rate of a stock that will define how well/bad it will do. What is more important is if the company does better or worse on what the market expected.

10 years ago


Nice analysis of stock market and economy. Keep up the good work!

This is the precise reason, why stock market gurus like Warren Buffet/ Benjamin Graham have advised, time and again, that for an average investor low fee passive index funds investing is the best way invest and to do this is by daily cost averaging, on a long term basis, meaning in both good and bad times.

Graham said, “Hold an index fund for 20 yrs or more, adding new money every month, and you are all but certain to outperform the vast majority of professional and individual investors alike.”


Michael James
10 years ago

@Ed: The standard correlation measure looks for a linear relationship. If the relationship is nonlinear, correlation can be zero even if one quantity completely depends on another. Even if the economy and stocks are uncorrelated, this does not mean that they don’t affect each other. It seems to me that they obviously do. It’s just that the effects tend to be complex. However, I agree with the conclusion that investors are best not to focus on the economy in deciding how to invest.

In odds we trust
10 years ago

I’m sorry, but how on Earth can you have a 33% correlation? Is this to say that the absolute opposite of Economy is more correct (67%)?

Though variables may be interdependent, or correlated to one another (two directions), correlation in its raw form only goes one way. i.e. The sun shining is correlated to some forms of skin cancer. This does not mean that cancer contributes to the shining of the sun.

The simple question this article needs to ask is what comes first, and is there a dependency? Stating 33% correlated is an absurd statement – and quite obviously detracts from the goal, because now I’m more interested in arguing whether that dependency is only part of the equation, its still part of the solution!

Imagine if Newton had stopped defining Force because Mass was only part of the solution – “There is only a % correlation between the force of gravity and mass, therefore we’re just as well to flip a coin to figure out how fast the object is travelling” Sir Bizaro Newton

What I don’t get about the stock market, is its value to the economy outside of Public Offerings. I buy a stock, I sell a stock. Where’s the value to the organization which we are supposedly ‘investing in’? One makes money, the other loses money – is it not all balanced at the end of the day? As far as I can tell, its simply an indicator of how the economy was performing. And if that’s correct, then the economy definitely matters. And perhaps its lack of value signifies that there is not an interdependency. Then again, when the stock market crashes, people generally stop buying, no?…

Michael James
10 years ago

@In odd we trust: Mathematical correlation is a number between -1 and +1. If it is 0, it means that the two things being compared are independent. A correlation of 33% (or about 1/3) means that the two quantities tend to move together a little. Ed got it wrong when he said that this is worse than flipping a coin. A flipped coin would have a correlation of 0 with unrelated things. If I had a known quantity that had a 33% correlation with the next year’s stock market, I would make a lot more money.

10 years ago
Reply to  Michael James

@ Michael, I noticed your blog post about correlation, was that in response to this post? :)

10 years ago

I guess my point has more to do with individual stocks and not the market in general. Take prolonged unemployment, this might cause some consumer stocks to suffer for a period (upscale retailers) while others (Walmart) will do well and their stock goes up.

Michael James
10 years ago

@Frugal Trader: My post is only tangentially related. Ed’s post got me thinking about common misconceptions of what correlation means.

Ed Rempel
10 years ago

Hi Germack,

That’s a great explanation of reason #1. The market prices in high economic growth. This is also why the top stocks long term are the ones that are almost always out of favour. Cigarette stocks and oil stocks have low P/Es most of the time, which is why they have the highest long term returns.

I’ll put you in for a vote on reason #1.


Ed Rempel
10 years ago

Hi Michael,

You linear correlation comment would be accurate if you compare the economy to the stock market year by year. However, that does not explain the 100-year correlation shown in the chart. It is not a year-by-year linear correlation, it is just a comparison of the countries in the chart, which shows that generally the stock markets perform better in slower growing economies.

You are obviously a math guy with a good understanding of what the numbers say. Your comment about a coin flip being a zero correlation is correct. However, if you try to use the economy as a prediction for the stock market (as in the last article), there is a 33% correlation between the stock market this year and the economy next year.

So, even if you could accurately predict the economy for 2 years from now, that would only be a partial help in predicting the stock market for next year. If you use an accurate prediction of the economy 2 years from now, it would only correctly predict next year’s economy 33% of the time, which is not good.

The coin flip would be accurate as a predictor 50% of the time, while using the economy to predict the stock market would only be right 33% of the time – which makes it useless.

So, should I put you down as a vote for reason #4 – the stock market and the economy are just different like chalk and cheese? You mentioned that the cause is just “complex”.


Ed Rempel
10 years ago

Hi Odds,

Michael described it well. A 33% correlation is common in many factors. It is a scale between -1 and 1, so .33 (or 33%) mean they move in the same direction more often than in opposite directions, but not by much.

For example, the correlation of stocks to bonds varies, but is usually between 20-40%. Sometimes it is 60%, sometimes -20%, but is usually averages around 20-40%.

Similar to the economy, bonds are not a close enough correlation to be a good predictor of the stock market.

Your example of mass and force is interesting. While mass x acceleration – force, you cannot predict force if you only know mass and not acceleration.

That is a good example of what might be the story. The economy affects the stock market, but it is only one of many factors, so knowing the economy alone tells you hardly anything about where the stock market is going.

I take it your vote is for still believing in the correlation (as opposed to reason #2 that there are many factors or #5 that they are just different).


Michael James
10 years ago

@Ed: A correlation of 33% does not mean that the two quantities move together 33% of the time. A correlation of 0 means that they go together roughly half the time. A correlation of 33% has a rough meaning that the two quantities go together two-thirds of the time. So if you have perfect insight into a measure of the economy, this would give a very useful advantage in investing. However, I don’t believe that anyone has perfect insight into the economy, and so predictions about the economy are fairly useless for predicting stock market returns.

I don’t have any useful insight into the nature of the relationship between the economy and stock returns other than to observe that it appears to be complex. One thing that you mentioned in #5 that is very true is that the constituents of the index change over time and this amounts to a form of active investing by the experts who control the index. This makes it possible for the index to outperform the average of all stocks.

Tareq Morad
10 years ago

I think this is a well written article and i can appreciate the value in exposing common mis-conceptions about investing in the stock market.

At the end of the day it’s all speculation. Very few people have ever constantly outperform the stock market, so the easy answer would just be index funds, but there’s little excitement in that, which is what investors in the stock market are after.

Otherwise, there are other options to comparable returns without the speculation, timing and risks of traditional investments.

10 years ago

Good article. For us, we invest for the long term and 20 years down the road the world economies will be much different than they are today.

Ed Rempel
10 years ago

Hi Michael,

A correlation of zero might mean that 2 items move the same half the time and opposite half the time, but it could also mean that they move randomly and differently from each other 100% of the time.

For example, if the stock market moved through normal cycles while the economy did not change at all, that would be a correlation of zero. They moved the same none of the time, but they also moved opposite none of the time.

The stat that shows the portion of movements you explained by a different factor is called the “correlation of determination” and shown as R-squared. It is the square of correlation.

Therefore, a correlation of .33 actually means that only 11% of movements of one factor can be explained by the other.

In any event, you are right that nobody has perfect insight into the future of the economy, so predictions based on it are essentially useless.

Don’t forget that the 33% correlation is a 1-year lag with the economy next year vs. the stock market this year. This article gives a different story that long term lower growth of the economy generally leads to higher stock market growth.

Thanks for the vote for #5.


Ed Rempel
10 years ago

Hi Everyone,

The score by my count so far is:

Reason #1: 2
Reason #2: 0
Reason #3: 0
Reason #4: 0
Reason #5: 1
Still believe in the correlation: 5


Brian Poncelet, CFP
10 years ago

Hi Ed,

What is your take on the Japanese economy? The Nikkei 225 index which includes:
Foods, Automotive (like Honda, Toyota), Manufacturing (Yamaha) Mining, Pharmaceuticals, Construction, Electronic Machinery (Sony,Cannon,Sharp) and many more industries.

The 15 year average (Globe Hysales) (no fees) is -3.66% So 15 years ago a $10,000 investment would be worth $5,719 (at the end of July).

Interest rates are near zero, debt (government) is high, real estate has been falling for years.

Another story (August 11, 2010)

(Reuters) – China has been buying record amounts of Japanese government debt because it is less risky than U.S. debt, at least in the short term, a Chinese government economist said on Wednesday.

Michael James
10 years ago

@Ed: You meant “coefficient of determination”. This measure only detects linear relationships. None of these measures can tell you if two quantities have a nonlinear relationship. Try typing a column of integers -10,-9,…,-1,0,1,…,9,10 into Excel and a second column equal to the squares of the corresponding entries in the first column. The CORREL() function will tell you that the correlation is zero. Yet the entries in the second column are obviously completely determined by the first column. Looking at correlation cannot tell you that there is no relationship between stock returns and GDP. It can only tell you the degree to which there is a linear relationship.

Stefan Alexander
10 years ago

Great article, and interesting facts to back it up. In general, I support the idea that conventional wisdom can be very wrong, although I also think it’s fair to be skeptical since there’s many “sensational” articles that claim to have a “hidden secret” that goes against conventional wisdom.

In this case, the facts do seem to back up the claim.

I think all 5 reasons make sense and play a part to some degree. But if I had to case my vote for one of them, I’d choose #1 which I would guess to be the greatest contributor.

10 years ago

The title of this post and the article itself are a little misleading.

There are good reasons to think why current indicators of macroeconomic performance will not help you choose which assets and in what proportions to include in your portfolio. Some of them have been discussed here – e.g. the complexity of the relationship between the macroeconomy and individual assets.

However.. the long run growth of the economy does ultimately determine the overall performance of financial assets.

Imagine that the stock market was the only means of generating capital for any investment. This means, absent bubbles and ‘leaks’ out of the system to other countries, that the current market cap (value) or the entire stock market is the value of all the physical capital in the economy.

In the long run, with several simplifying assumptions, the marginal product of capital – that is the return to holding a unit of capital – is equal to the growth rate of the economy. (cf. solow model)

So in a world where equities have all the claim on the returns to capital, when the long run growth rate rises, the returns to capital, and therefore the returns to stocks, rise. When the growth rate falls, the returns to capital, and therefore stocks, fall.

The real world is more complex – stocks are not the only means of raising capital and paying for investments. Nor are changes in the growth rate likely to be the only cause of booms and slumps – though the jury’s still out on all the causes of business cycle.

In the short run, the growth rate might be pretty useless for predicting investment performance. In the long run, while it might not help you with your investment strategy, the long term growth rate will be the key determinant of the returns to capital.

10 years ago

The analysis seems to show that the stock market over-estimates the growth of high growth economies and under-estimates the growth in low growth economies.

I have read a few times that there is a belief that equity investors and equity fund managers place higher growth economies in favour, likely overly so. This would explain the reason for the results of the study. So, I guess I believe reason #1 is fairly accurate at explaining the results.

I think that earnings are certainly correlated with GDP. However, stock market performance depends on the over/under performance of earnings compared to expectation and not earnings themselves.

10 years ago

Very intereresting study. Thanks to Ed.

In both Dimson and Siegels’ studies, the -0.27 and -0.32 correlation co-efficient for the developed countries shall not be interpreted as the stock market and the economy was going in opposite direction. It shall be interpreted as the studies were simply inconclusive. Period. In general, any correlation co-efficient between +/- 0.1 to +/- 0.5 shall be interpreted as inconclusive.

On the other hand, Siegels’ study in emerging markets is conclusive. The economy and stock market growth in these markets was very independent of each other.