With government stimulus hopes in developed nations in question and some economic data showing slowing growth of late, many financial commentators we follow are increasingly seeing the recent growth-rate pop as fleeting—and worrying it spells trouble. In the UK, May’s weaker-than-forecast monthly gross domestic product (GDP, a government-produced measure of national output) reading caught some experts off guard.[i] In the US, research outfits whose work we follow are already projecting slower-than-average GDP growth—and the possible implications—after government aid elapses. Now, we have long argued the reopening-driven growth surge would fade fast. But we disagree with the worried conclusions. Equities can do great in a slow-growth economic environment—worthwhile to keep in mind for investors.
When we see financial commentators argue a development or trend is good or bad for share prices, we find it valuable to research historical market data. The past may not foretell the future, but in our experience, it can help you assess probabilities—and provide data to test claims. Before last year’s pandemic-driven economic contraction, US annual GDP growth averaged 2.5% from 1989 – 2019.[ii] Over that period, we found stretches when strong GDP growth coincided with strong US equity returns. For example, from 1996 – 1999, annual GDP growth averaged 4.4%, and the S&P 500 delivered four years of returns above 20%—including 33.4% in 1997.[iii] But markets don’t need strong growth to surge. US shares rose 37.6% in 1995—its best year of the decade.[iv] Yet GDP grew 2.7% that year, its weakest reading of the 1990s expansion.[v]
Moreover, periods of weaker-than-average US GDP growth haven’t hurt US shares, as evidenced by the last bull market (an extended period of generally rising equities). From 2009 – 2019, US annual GDP growth averaged 1.9%—a percentage point below its 2.9% average from the preceding 20 years.[vi] But the S&P 500 spent just one year in the red during that stretch—2018, when GDP grew 3.0%, its second-fastest rate of the period.[vii] American equities’ best year was 2013 when they rose 32.4%.[viii] Yet GDP grew just 1.8% that year—its third-weakest during the expansion.[ix] More broadly, the S&P 500 was up 351% from 2009 – 2019, far exceeding the non-US developed world.[x] Slower-than-average GDP growth didn’t stop American stocks’ world-leading ascent.
This isn’t just an American phenomenon. Similar to the US, the UK enjoyed strong GDP growth and market returns in the late 1990s. In 1997, GDP grew 5.0% and shares were up 27.5%—both the best marks for the decade.[xi] But like the US, fast growth didn’t ensure robust returns. In 1994, UK GDP grew 3.8%—the 1990s expansion’s second-fastest rate—yet UK equities dropped -7.0%, their only negative year during the span.[xii] Moreover, UK markets’ second-best year (27.4%) was 1993, when GDP grew 2.5%—the second-slowest growth rate of the UK’s 1990s expansion.[xiii] More recently, annual UK GDP growth averaged 1.3% from 2009 – 2019—more than a percentage point below its 2.4% average from the preceding 20 years.[xiv] But despite this and deafening Brexit noise from 2016 – 2019, UK shares delivered double-digit positive returns in three of the four years.[xv] Furthermore, UK GDP grew fastest in 2014 (2.9%)—yet the MSCI UK was up just 0.5% that year.[xvi]
In our view, these data reinforce an important lesson: Shares don’t require fast GDP growth to rise. If they did, equities in countries with the fastest-growing GDPs (e.g., Emerging Markets, which include China and India) would virtually always lead. They don’t.[xvii] Broad economic growth is one factor markets consider, but it isn’t the only one, based on our research. Equities also care about political and regulatory developments, monetary policy and other variables—and how these factors affect corporate profits over the next 3 – 30 months, in our view. Moreover, investor sentiment is crucial, too, as shares move most on the gap between expectations and reality, in our view. Fears of slow growth portending a recession or trouble for shares can lower expectations. If reality turns out better than anticipated, our research shows that positive surprise often boosts equities.
Now, we aren’t saying growth rates don’t matter at all—they are important when considering category leadership. Our research shows value shares—which are usually smaller companies in economically sensitive sectors that tend to pay higher dividends versus reinvesting profits into the business—move more based on expected growth rates. In our view, this is why value usually does best early in a bull market, which usually coincides with the beginning of economic recoveries. Value firms usually get disproportionately pummelled late in a bear market—a fundamentally driven, extended market downturn exceeding -20%—as investors fear they won’t survive the recession that usually accompanies a bear market. Some won’t, but the panic usually goes too far. Markets start to pre-price a return to bank lending that will power the economic rebound—benefitting value shares, which our research shows usually bounce back strongest as a new bull market begins.
Though this bull market may be young on paper, shares are behaving like it is in its latter stages, in our view. We think the likely return to pre-pandemic, slow-growth trends is a valid reason against value shares. It also implies growth shares—less economically sensitive firms that tend to finance their own growth with reinvested profits—will resume their leadership. They held that distinction for the majority of the 2009 – 2020 bull market after value had an early jump. As we highlighted earlier this month, growth may have retaken that mantle already—and will likely hold on to it for the rest of this bull market, in our view.
[i] “UK Economic Growth Slows in May,” Staff, BBC, 9/7/2021.
[ii] Source: BEA, as of 15/7/2021. Percent Change From Preceding Period in Real Gross Domestic Product, 1989 – 2019.
[iii] Ibid. and FactSet, as of 14/7/2021. Statement based on S&P 500 Total Return Index, annual returns, in USD, 1996 – 1999. Currency fluctuations between the US dollar and British pound may result in higher or lower investment returns.
[iv] Ibid. S&P 500 Total Return Index, in USD, 31/12/1994 – 31/12/1995. Currency fluctuations between the US dollar and British pound may result in higher or lower investment returns.
[v] Ibid. Statement based on annual US GDP growth in 1995.
[vi] Ibid. Statement based on annual US GDP growth, 2009 – 2019 and 1989 – 2008.
[vii] Ibid. Statement based on S&P 500 Total Return, annual returns, in USD, 2009 – 2019 and annual US GDP growth in 2018. Currency fluctuations between the US dollar and British pound may result in higher or lower investment returns.
[viii] Ibid. S&P 500 Total Return Index, in USD, 31/12/2012 – 31/12/2013. Currency fluctuations between the US dollar and British pound may result in higher or lower investment returns.
[ix] Ibid. Statement based on annual US GDP growth in 2013.
[x] Source: FactSet, as of 14/7/2021. S&P 500 Total Return Index, in USD, 31/12/2008 – 31/12/2019. Currency fluctuations between the US dollar and British pound may result in higher or lower investment returns.
[xi] Source: ONS and FactSet, as of 13/7/2021. Year-over-year GDP growth and MSCI United Kingdom return with net dividends, in GBP, 31/12/1996 – 31/12/1997.
[xii] Ibid. Statement based on year-over-year GDP growth in 1994 and MSCI United Kingdom return with net dividends, in GBP, 31/12/1993 – 31/12/1994.
[xiii] Ibid. Statement based on year-over-year GDP growth in 1993 and MSCI United Kingdom return with net dividends, in GBP, 31/12/1992 – 31/12/1993.
[xiv] Ibid. Year-over-year GDP growth, 1989 – 2019.
[xv] See note x. Statement based on MSCI United Kingdom return with net dividends, in GBP, 2016 – 2019. Returns were negative in 2018.
[xvi] Ibid. Statement based on year-over-year GDP growth in 2014 and MSCI United Kingdom return with net dividends, in GBP, 31/12/2013 – 31/12/2014.
[xvii] Source: FactSet, as of 18/2/2021. Statement based on MSCI USA, MSCI Japan, MSCI United Kingdom, MSCI Germany and MSCI Emerging Markets returns with net dividends, in USD, 31/12/1992 – 31/12/2020. Currency fluctuations between the US dollar and British pound may result in higher or lower investment returns.
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