In a recent note to clients, JPMorgan delved into the relationship between economic growth and long-term equity returns, with a focus on developed markets (DM) and emerging markets (EM).
In developed markets (DM), JPMorgan finds a clear link between economic growth and equity returns. A 1% increase in long-term real growth is associated with roughly 3% higher equity returns on average.
This boost comes primarily from higher earnings growth, with additional contributions from increased valuations and currency appreciation.
“About half of the return impact of higher growth in DM comes from higher earnings growth,” JPMorgan states. “Slightly less than half comes from higher valuations. The rest is from currency strengthening."
Emerging markets, however, tell a different story. Here, the connection between economic growth and equity performance is much weaker. JPMorgan points out that many EM equity markets are not as closely tied to their domestic economies as those in developed markets.
For instance, EM stock market capitalizations are often just a fraction of GDP, compared to a much larger proportion in DMs. As a result, JPMorgan’s research finds "no relationship between forecast growth and actual returns" in emerging markets, challenging the assumption that faster-growing economies should deliver better stock market returns.
The report also addresses the practical challenges of using economic growth as a predictor for equity returns. Long-term growth forecasts are notoriously difficult to make accurately, and JPMorgan notes that there’s often a significant gap between forecasted growth and actual returns.
"We see no relationship between forecast growth and actual returns. Actual returns are also unrelated to recent past growth," the report emphasizes.
Despite this, the bank suggests that investors with strong convictions about a particular country’s growth prospects might still consider incorporating these views into their investment strategies, though with an understanding of the risks involved.
JPMorgan’s analysis underscores that while economic growth can be a useful indicator in developed markets, it’s far from a guaranteed predictor of equity performance, especially in emerging markets.
The takeaway for investors is to approach growth forecasts with caution and to be mindful of the broader factors that drive market returns.
"Being mindful of the difficulties forecasting long-run growth, the results suggest it would still be reasonable for an investor to incorporate any high conviction views about growth or growth differences into their asset allocation process."