Investment Return

As People Get Richer, Do Investment Returns Get Better?

No, they don’t. Research shows there is a negative correlation between gross domestic product (GDP) per capita – a measure of how wealthy people in a country are becoming – and investment returns.

In other words, the countries with the fastest growing economies don’t always produce the highest investment returns and vice versa. For example, between 1900 and 2013, South Africa rewarded investors with long-term stock market returns of about 7.4 percent while its per capita GDP growth was 1.1 percent. At the opposite end of the spectrum was Ireland, where markets returned 2.8 percent while per capita GDP growth was 4.1 percent. The Economist described the research findings:

“The quintile of countries with the highest growth rate over the previous five years produced average returns over the following year of 6 percent; those in the slowest-growing quintile produced returns of 12 percent… Why might this be? One likely explanation is that growth countries are like growth stocks; their potential is recognised and the price of their equities is bid up to stratospheric levels. The second is that a stock market does not precisely represent a country’s economy – it excludes unquoted companies and includes the foreign subsidiaries of domestic businesses. The third factor may be that growth is siphoned off by insiders – executives and the like – at the expense of shareholders.”

Here is another interesting economic tidbit. While past economic growth does not predict future equity market performance, changes in stock prices do correlate to future economic growth. That’s because expectations play an important role in markets. The expectation of poor future economic performance may cause a country’s share values to fall, and vice versa. A research report from Schroders said, “If expectations are key, a poor economic outlook will already be priced in, and investors’ returns will depend instead upon whether market expectations are overly optimistic or pessimistic with regards to future GDP growth.”

 
 
 

Lexington Wealth Management