Does high GDP mean good stock returns either in the Middle East or globally ?
Emerging economies now contribute more than 50 percent of the growth in the world’s gross domestic product (GDP) and most fund managers believe this is set to continue for the foreseeable future. But rapid economic growth in emerging countries does not necessarily mean that their stock market returns are going to do the same.
“Investors may also be overweighing emerging markets based on the widely held view that emerging economies will grow faster than developed markets, and thus their financial markets will outperform developed markets,” said Jeff Molitor, chief investment officer for Vanguard Europe in a Dec-ember 2010 note. But the large asset manager warned: “Our analysis shows that the average cross-country correlation between long-run GDP growth and long-run stock returns has been effectively zero.” This research holds across major equity markets over the past 100 years and across both emerging and developed markets over the past decades.
The research further showed emerging market investors were rewarded not because of high economic growth, but rather because of comparatively low equity valuations — shares in companies were cheap. In a nutshell, good company earnings and low valuations, along with strong economic growth, are needed to pick winning stocks in emerging markets. But, in a recent note, Schroder’s head of emerging market equities, Allan Conway, differs. He points out that there are many examples which show that when an economy is going through a period of rapid economic growth and development, the stock market does provide premium returns.
During Korea’s rapid period of GDP growth of 9.6 percent per annum between 1981 and 1992, the stock market provided investors with an 18.2 percent annual return. Since August 1998 until the end of June 2011, global emerging markets were up 558.7 percent. In comparison, MSCI World has risen just 87.8 percent. “There has been no re-rating of emerging equities. The performance has all been driven by earnings on the back of strong economic growth,” says Conway.
To buttress his point further, Conway cites a May 2011 Goldman Sachs research note, âLinking GDP growth and equity returns’ which found strong positive relationship for both emerging and developed markets for GDP growth today and equity returns in the previous year.
Mark Mobius, executive chairman of Templeton asset Management Limited, says: “Stock markets are a leading indicator and move up or down before the economy moves. Clearly there is a close relationship between the growth and health of an economy and the movement of stock prices. A healthy economy means healthy companies.”
George Shehadeh, chief executive of Doha-based Amwal, an investment bank and asset management company, agrees that simply looking at GDP growth rate is not sufficient for selecting markets — developed or emerging — in which to invest. Valuations are equally important, he says, citing the example of China. China’s equities have been performing poorly since its 2007 peak because valuations were extremely high — around 45 times price earnings — when its economic growth continued at an annual rate of about 10 percent.
Haissam Arabi, chief executive of Gulfmena Investments, points out that while China’s GDP is still growing at more than nine percent, its equity market is one of the worst performing this year. “China is expected to suffer further from US economic slowdown while it continues with its tightening policy, [so] sentiment in the market is pricing in future prospects or worries rather than present GDP growth. Markets always price in a virtual future scenario. If it’s perceived positive markets go up and visa versa.”
The coefficient between equity returns and growth in gross domestic product is never going to be perfectly correlated in either direction, says Nick Price, the manager of Fidelity Funds Emerging Market Fund and Fidelity Funds Emerging Europe, Middle East and Africa,
“Sentiment drives the oscillations of the markets in the short run, but a company’s earnings and dividends are ultimately going to drive the performance of the company in the long term. Strong economic growth creates a conducive environment for strong companies to deliver attractive, real earnings,” he adds. However, Shehadeh points out there is nothing wrong with taking GDP as a macro proxy for earnings, although obviously GDP is a broader measure of earnings in a country rather for a specific company. “GDP is a measure of not only listed corporate earnings but also private corporate, personal and government tax earnings.”
Fidelity expects emerging markets to remain volatile in the current environment. But, they point out that in the long term it is impossible to ignore the fact that the majority of the world’s population, reserves and GDP growth is coming from those countries that have yet to be fully developed. “Yet, as per the MSCI World, emerging markets are only 13 percent of the world’s stock market. That in itself cannot be ignored and that is where the long term growth remains,” says Price.
Dubai Company earnings and gross domestic product (GDP) growth in the Middle East and North Africa (Mena) region have been particularly strong. Between 2001 and 2010, overall earnings grew by an annual average of around 22 percent. This is largely because of the high oil price, which during this period had an average annual growth rate of 13 percent, to about $80 (Dh293) in 2010. “The significant natural resources in the region provide both cheap inputs for companies — cheap energy and cheap feedstock — and significant revenues for government to spend on infrastructure and subsidies,” George Shehadeh, chief executive of Doha-based Amwal, an investment bank and asset management company. He added: “In addition, the consumer in the region is very underleveraged and has significant room to spend. The recent public unrest, which led to increased aid from the governments will likely increase consumer spending even further.”
According to Amwal’s calculations, the average return on equity (ROE) of the companies listed in the Mena region has been around 22 percent in the last five years, one of highest in the world. To compare, the average ROE during the same period has been around 15 percent in China, 14 percent in Korea, around 20 percent in India.
Double the figures
The average ROE of banks in Mena has been around 20 percent in the last five years, almost double the figures seen in developed markets. “Our favourite theme in Mena equity markets is their domestic growth stories and on this theme, Qatar and Saudi Arabia look best,” Shehadeh said.
“Qatar has a strong investment programme of around $65 billion in the next five years. This is equal to an annual spending of around ten percent based on 2010’s GDP, which should translate into strong GDP as well as earnings growth, [while] valuations remain reasonable.”
“GDP has grown faster due to a sharp rise in LNG export capacity as well as global energy prices, but the stock market is mostly non-energy,” says Shehadeh. Core energy assets in Qatar are not listed on the Doha exchange. “Saudi Arabia on the other hand has a young and growing consumer base, increasing urbanisation, strong oil revenues and heavy government investments, which are expected to provide strong growth. Both Qatar and Saudi markets are valued at around 11 times current year earnings.”
Statistically, the correlation may not be evident, but broadly the movements in the direction of GDP, equity indices and earnings were similar.
The reason there won’t be 1-on-1 correlation is that Qatar’s GDP is two thirds energy, which are mostly unlisted assets. The equity market on the other hand is mainly banks, telecoms and real estate. Industries Qatar, for example, is the only energy related stock but it’s a mere 15 percent of the index.
At a glance, strong fundamentals:
558.7%, Gains in emerging market equities between August 1998 and June 2011
22%, Annual average earnings growth reported in Mena between 2001 and 2010
87.8%, Gains in the MSCI World index between August 1998 and June 2011
13%, Average annual growth rate in oil price between 2001 and 2010
correlation, similar movements:
Statistically, the correlation may not be evident, but broadly the movements in the direction of GDP, equity indices and earnings were similar. Between 2006 and 2008, GDP, equity index and earnings were up, 2008-2009 down then flat, and since 2009 end all are up.The reason there won’t be one-on-one correlation is Qatar’s GDP is 2/3 energy which is mostly unlisted assets. The equity market on the other hand is mainly banks, telecoms and property. Industries Qatar, for example, is the only energy related stock but it’s a mere 15 percent of the index.
—Source: George Shehadeh, Chief Executive, Amwal, Doha.