prologue
Turn on Bloomberg TV or CNBC at any time of the day and you’re more likely to have a host explain the stock market’s daily ups and downs as a function of the latest economic news. Unemployment is down and stocks are up. Inflation is rising and stocks are falling. and so on. The underlying assumption is that the stock market represents the economy. But most economic data is released quarterly, and there are many days when there is no significant news. So what are stocks trading on that day?
And what about when the stock market goes wild?After all, too many investor enthusiasm technology bubble For example, in 2000 and 2021. Economic growth was strong at the time, but in hindsight it could hardly justify such extraordinarily high returns and valuations. So how important is the economy to the stock market? Sometimes it matters a lot, sometimes it doesn’t. Explore.
US GDP growth and stock market returns
The US economy is primarily driven by consumers, who spend 70% of GDP. The remaining 30% is split roughly evenly between private investment and government spending. Net exports are almost zero. The United States imports slightly more goods and services than it exports.
This composition is hardly the same as the US stock market, where technology, healthcare and finance are among the top three industrial sectors. Not surprisingly, many companies sell directly to consumers, but tend to focus on their business and international markets.For example, Apple, the publicly traded company with the largest market capitalization, It produces nearly 70% of the high. So, is the US stock market really representative of the larger economy?
Annual changes in US real GDP and the S&P 500 have broadly followed the same trend over the last two decades. When the economy crashed in 2008, so did the stock market. As the economy recovers from the global pandemic in 2021, so does the S&P 500.
US real GDP growth and US stock market returns since 2002
However, when we extend the lookback to the extent that the available quarterly US real GDP data suggests, the relationship between US GDP and the S&P 500 becomes less clear. Between 1948 and 1962 they tracked each other closely, but less closely after that: the US economy survived several stock market crashes until the 1970 oil crisis. nevertheless expanded rapidly. The S&P 500 moves synchronously again.
US Real GDP Growth and US Stock Market Returns Since 1948
Correlation between US economy and US stock market
To quantify the relationship between the US economy and the stock market, we calculated 10-year correlations. Between 1958 and 1993 the correlation dropped from 0.7 to zero. It then rose to 0.8. The correlation decoupled again when the economy stalled during the 2020 COVID-19 crisis, but the S&P 500 ended the year strong thanks to massive fiscal and monetary stimulus. rice field.
US Real GDP Growth and US Stock Market Returns: 10-year rolling correlations, since 1958
Use annual data from the MacroHistory Lab to date your analysis back to 1900. The stock market is prescient and tends to anticipate the flow of economic news, so we added a one-year time lag. So I compared the 2000 GDP numbers to the performance of the S&P 500 in 1999.
Again, the US economy and stock markets have been highly correlated throughout most of this period. Only four times did his correlation drop significantly: The Great Depression, World War II, the 1990s, and a global pandemic. All of this suggests that the S&P 500 has been a good indicator of the US economy for the past 120 years.
US Real GDP Growth and US Stock Market Returns: 10-year rolling correlations, since 1900
international evidence
However, so far our analysis has been limited to the United States. Do GDP growth and stock market performance show similar correlations in other parts of the world?
Evidence from the Asia-Pacific region tells a different story. China’s economy expanded at a fairly regular and impressive rate from 1991 to 2019. However, the performance of the Shanghai Composite Index has been less consistent. Some years were exceptional with over 100% gains, while others were dismal with over 50% declines.
What explains this discrepancy? Perhaps the Shanghai Composite, which was only launched in 1991, has not yet reached the stage of reflecting China’s modern and dynamic market-based economy. Historically, Shanghai Composite has listed many state-owned enterprises (SOEs) with different governance structures, for example. China’s private investment market is also bubble-prone, so Chinese regulators have imposed a limit of 10% per day on stock price movements.
China’s GDP growth rate and the Shanghai Composite Index
Other industrialized markets show different relationships depending on the country and time frame analyzed. After computing the rolling correlations for 14 developed markets over 10 years, from 1900 to 1959, from 1960 to 1999, and from 2000 to 2020, the correlation between real GDP growth and stock market returns is We found that the median increased from 0.2 to 0.6.this is decades of relative peace Coupled with the trend towards a more capitalist economy with a larger and more diversified stock market.
However, not all countries followed the same trajectory. Belgium’s correlation between her GDP growth and stock market returns has changed little over the 1960-1999 and 2000-2020 periods, while Australia’s correlation has been negative over the last two decades. Steady GDP growth coupled with rising and falling stock markets.
Real GDP Growth and Stock Market Returns: A 10-Year Rolling Correlation
Further consideration
A lack of long-term data limits the analysis to developed markets, but as emerging market stock markets are decoupled from the economy and tend to be dominated by retail investors, the correlation is We expect it to be lower in emerging markets.
But even if the economy and stock markets are highly correlated, high-growth countries do not necessarily result in good investments.of Low volatility factor Low-risk stocks outperform high-risk stocks, at least on a risk-adjusted basis. growth stock is essentially zero. The same can be true country by country.
Nicolas Rabener and minor term team, their research report.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, and the opinions expressed do not necessarily reflect those of CFA Institute or the author’s employer.
Image credit: ©Getty Images / Dusan Bartolovic
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Nicholas Ravener
