Economic growth is unrelated to stock market performance

Economic growth cannot predict stock pricesWill it surprise you to know there is almost no relationship between economic growth and  stock market performance? If you are spending time worrying about economic growth when making your investment decisions, it’s likely you are wasting your time.

Warren Buffett, during his most recent shareholder’s meeting, told investors he has never made an investment decision based on what he thinks economic growth is going to do. One of the greatest unit trust fund managers of all time, Peter Lynch, remarked: “If you spend 13 minutes a year trying to predict the economy, you have wasted 10 minutes.” This might seem surprising to most. It seems intuitive that investors must have a good “feel” for the direction of  economic growth, because companies will either be operating with economic tailwinds or struggling with difficult conditions. If the economy is doing well, one would expect more opportunities to make profit, which should translate to rising share prices.

It’s not about economic growth, or the economy itself

There is a great study by Holger Sandte, Chief Economist at WestLB Mellon Asset Management, in which he covers a range of topics about how share prices and economic growth relate. The finding that is most interesting to me is that there is absolutely no relationship between the direction of share prices and  economic growth.

I can partially understand this finding, because the stock market is forward-looking. It’s always trying to anticipate what’s going to happen. Therefore current prices are based on investors’ future expectations.

In contrast, economic growth data is always historic. It can only tell us what has already happened. If we believe stock prices are forward-looking, it might make more sense to see if share prices relate to economic growth data from a later date. For example, will this work if we review the direction of the stock markets from January to March and compare this data with economic growth from April to June? Sandte’s study could not find a meaningful relationship with such a delayed comparison. In other words, economic growth data is interesting, but not relevant to equity investors.

If economic growth is not, what is relevant?

Consumer confidence is a totally different matter. According to Sandte’s study, there has not been a prolonged period of time when US consumer confidence and share prices have moved in opposite directions. If consumers are feeling confident, it will translate into rising stock markets over time. The good news for investors is that consumer confidence is regularly measured and published in the US and many other countries around the world.

In South Africa the respected Bureau for Economic Research at Stellenbosch University publishes the Consumer Confidence Index, which you can obtain from their website. The survey has been done since the 1970s. It provides reliable insights into the general population’s thoughts about their own economic well-being.

It’s concerning to note SA consumer confidence dropped substantially from December 2012 to March 2013  and is currently at a nine-year low point. This might not bode well for our stock markets, unless things change to make South Africans feel more positive about their financial futures.

I think there is some merit for sophisticated investors to monitor consumer confidence. But only as one of a few key indicators. However, I would not rely on this as an absolute guide to our stock market’s long-term performance. Markets move so quickly  it’s impossible to invest successfully by anticipating what people are going to feel or how they are going to spend in the short-term (periods shorter than two years).

Most of us don’t have the time to research and monitor these indicators properly. It’s better to focus on buying the index, or quality companies that can adapt to all economic growth conditions. You should always ensure your overall portfolio of investments is sufficiently diversified to survive all market conditions.

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