Philip Saunders, a portfolio manager at Investec Asset Management in London, has written an article for Institutional Investor saying that when the investment community evaluates the attractiveness of a given economy, they tend to focus on the level of economic growth in emerging markets and specifically GDP growth. But not much interest has been directed to the sustainability of this growth or its distribution within society. In fact and historically, there has been an insignificant relationship between aggregate economic growth and stock returns for the following reasons:
- GDP growth is a backward-looking statistic, whereas equity markets show the present value and look toward future growth and earnings.
- GDP measures one nation’s economic output while stock market indexes, in emerging as well as developed markets, reflect earnings for numerous countries, a key measure in the globalized economy.
- Equity returns correlate more with the bottom line, whereas GDP is more closely associated with the top line. Many emerging markets have not been able to translate expansion in gross sales and revenues into net earnings.
- GDP gives little sense of the distribution of economic growth within a society, that is, who is actually benefiting from a country’s total increase in output or economic growth. Over the long term, though, there is likely to be a stronger connection between GDP and the distribution of economic growth, but investors should be wary of equating the two because one doesn’t necessarily lead to the other.
To read the whole article, With Emerging Markets, Quality Trumps Quantity, go to the website of Institutional Investor.
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