Many investors are mistaken in the belief that investing in the stock markets of countries that have achieved higher rates of economic growth will generate superior returns. Markets reflect future as opposed to past growth
New research in the Credit Suisse Global Investment Returns Yearbook 2010, by professors from London Business School.
London / Zurich, 16 February 2010
Prompted by the robust performance of emerging markets following the global financial crisis, the 2010 Yearbook focuses on what role emerging markets should have within global equity portfolios and what returns can be expected from them. It also examines the closely related questions of whether economic growth is a reliable indicator of future equity returns, and whether equity markets reliably anticipate future growth.
Marking a decade since its launch and drawing upon its unprecedented database of 110 years of investment returns across all major asset categories, the 2010 Yearbook begins by examining the long run performance of emerging markets. Although the opening years of the 21st century have been a lost decade for equity investors, with the MSCI world index giving a return close to zero, emerging markets have been a bright spot with an annualized return of 10%. Despite these excellent returns, their longer run performance has been less impressive. Over the longest interval that it is possible to examine, namely the 34 years from 1976–2009, they underperformed the MSCI world index by 1% per annum.
The authors show that emerging markets are still appreciably riskier than developed markets, both individually and as a group. The risk gap has narrowed, however, and is likely to decline further. Their research shows that emerging markets are a geared play on developed markets, and because of this, investors should expect modestly higher returns from emerging markets of around 1½% per year as compensation for this higher risk. The diversification benefits afforded by emerging markets have diminished over time, but they remain important and worthwhile.
The authors state that, “Emerging markets are now mainstream and will and should play an increasingly important role in global portfolios. Investors should not, however, neglect, or write off the prospects for, developed markets”.
The Yearbook goes on to examine the two closely related questions of whether economic growth is a useful indicator of future equity returns, and whether equity markets reliably anticipate future growth. It shows that, historically, the link between GDP growth and equity market returns has been much weaker than might be expected, and that there is no positive link between a country’s per capita GDP growth and returns from its stock market.
Furthermore, the Yearbook challenges the widely held view that investing in countries that are achieving strong economic growth will lead to higher investment returns. Markets anticipate economic growth, and historically, a strategy of investing in countries that have achieved higher economic growth has underperformed one of investing in countries where growth has been lower, or has disappointed. The authors argue that this may be akin to the value effect within stock markets, whereby, historically, value stocks have outperformed growth stocks. Economic growth does, of course, matter, and the authors show that clairvoyance about future economic growth would have been very valuable. They also show that, while one cannot predict stock returns from past economic growth, stock market returns are useful in forecasting future economic growth.
In addition to the articles by Dimson, Marsh and Staunton, the 2010 Yearbook features Jonathan Wilmot, Chief Global Strategist for Investment Banking at Credit Suisse, who examines the outlook for the USA. His analysis is informed by a very long run series stretching back in some cases to more than 200 years. He notes that US trend productivity and real earnings growth appear remarkably persistent at about 2 per cent per annum for 100 years or more. US equities are not over valued if you expect these macro trends to continue in the future. Moreover, US growth is strongly linked to emerging growth and vice versa. He concludes that: “If you believe in the potential benefits of technological change and the dramatic rise of the emerging world, then the next decade for US equities is likely to be a bright one.”
Giles Keating, Head of Global Research for Private Banking at Credit Suisse, said: “We are delighted to be associated with the Global Investment Returns Yearbook and the London Business School. This year’s analysis is both timely and insightful given the wide attention that emerging markets are receiving, and we hope that the Yearbook proves to be a valuable resource for global investors.”
Stefano Natella, Head of Global Equity Research for Investment Banking at Credit Suisse, added: “The issues examined in this year’s analysis further underline the unrivalled depth of the Yearbook’s database. By examining ideas that are at the forefront of investor thinking within a broader, long-term context, the Yearbook has again demonstrated why it is the global authority on long run asset returns.”
The Credit Suisse Global Investment Returns Sourcebook 2010 which is also published today contains a more extensive summary of long run capital market history than is possible within the Yearbook, with detailed tables, charts, listings, background, sources and references for every country. The Sourcebook provides extensive evidence on issues such as the importance of dividends in historical returns, the historical and prospective risk premium, and long run evidence on style effects such as size, value/growth and momentum.
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