With “stimulus” hopes in doubt and some data coming off the boil of late, pundits are increasingly seeing the recent growth-rate pop as fleeting—and worrying it spells trouble. In the UK, May’s weaker-than-forecast monthly GDP reading caught some experts off guard. In the US, research outfits 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. Stocks can do great in a slow-growth economic environment—worthwhile to keep in mind for investors.
When pundits argue a development or trend is good or bad for markets, it is worthwhile to review history. The past may not foretell the future, but it can frame 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.[i] Over that period, there were stretches when strong GDP growth coincided with strong US stock 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. But markets don’t need strong growth to surge. US stocks rose 37.6% in 1995—its best year of the decade. Yet GDP grew 2.7% that year, its weakest reading of the 1990s expansion.
Moreover, periods of weaker-than-average US GDP growth haven’t hurt US stocks, as evidenced by the last bull market. From 2009 – 2019, US annual GDP growth averaged 1.9%—a percentage point below its 2.9% average from the preceding 20 years.[ii] 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. American stocks’ best year was 2013 when they rose 32.4%. Yet GDP grew just 1.8% that year—its third-weakest during the expansion. More broadly, the S&P 500 was up 351% from 2009 – 2019, far exceeding the non-US developed world. Slower-than-average GDP growth didn’t stop American stocks’ world-leading ascent.[iii]
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.[iv] 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. 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. 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.[v] But despite this and deafening Brexit noise from 2016 – 2019, UK shares delivered double-digit positive returns in three of the four years.[vi] Furthermore, UK GDP grew fastest in 2014 (2.9%)—yet the MSCI UK was up just 0.5% that year.
In our view, these data reinforce an important lesson: Stocks 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. Broad economic growth is one factor markets consider, but it isn’t the only one. Stocks 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. Moreover, investor sentiment is crucial, too, as stocks move most on the gap between expectations and reality. Fears of slow growth portending a recession or trouble for stocks can lower expectations. If reality turns out better than anticipated, that positive surprise often boosts stocks.
Now, we aren’t saying growth rates don’t matter at all—they are important when considering category leadership. Value stocks—which are usually smaller companies in economically sensitive sectors—move more based on expected growth rates. 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 pummeled late in a bear market as investors fear they won’t survive the recession. Some won’t, but the panic usually goes too far. Markets start to pre-price a return to lending that will power the economic rebound—benefiting value stocks, which usually bounce back strongest as a new bull market begins.
But for reasons we have discussed on MarketMinder before, though this bull market may be young on paper, stocks are behaving like it is in its latter stages. The likely return to pre-pandemic, slow-growth trends is a valid reason against value stocks, in our view. It also implies growth stocks will resume their leadership—a distinction they held 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.
[i] Source: BEA, as of 7/15/2021. Percent Change From Preceding Period in Real Gross Domestic Product, 1989 – 2019.
[iii] Source: FactSet, as of 7/14/2021. S&P 500 Total Return Index, 12/31/2008 – 12/31/2019.
[iv] Source: ONS and FactSet, as of 7/13/2021. Year-over-year GDP growth and MSCI United Kingdom return with net dividends, in GBP, 12/31/1996 – 12/31/1997. Returns denominated in home country currency for consistency.
[v] Ibid. Year-over-year GDP growth, 1989 – 2019.
[vi] See note iv. Note: MSCI United Kingdom returns were negative in 2018.
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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.