Thursday, November 22, 2007

Economies and stockmarkets

In these days of doom and gloom about stockmarkets and concerns about a US recession and an ever weaker US$, it is refreshing to read a piece of research written by Jim O'Neill of Goldman Sachs about the correlation between GDP growth and stockmarket performance. From 1993-2005, China had the fastest economic growth in the world but its stockmarket fell 70% because the market was dominated by inefficient state-owned companies and the strong private companies chose to list in HK or the US instead to attract foreign investors. Since 2005, Chinese companies have been forced to become more competitive, more private companies have listed there and the market has boomed. This suggests that earnings growth and not economic growth per se, drives stockmarket returns. Equity returns are strongly tied to the business cycle. The average emerging market return during a recession is 5% versus 17% during periods of growth. The best returns are gained by investing at a time when an economy is coming out of recession: in 1996 Russian economic growth fell by 3.6%, however, if you'd invested in the Russian market that year, you would have made 151% in US$ terms. We're still waiting for the US recession so it's too early to think about diving in. Next year could be a different story though...

5 Comments:

Blogger kinglear said...

Ah yes, but GDP growth is a sine qua non for making people feel better, spend more money and hence drive up company earnings. But you are absolutely right about it being increased earnings that fuel equity growth. So now we have probable equity retreat because earnings don't look as if they will grow much soon.

2:02 pm  
Blogger Winchester whisperer said...

Yes KL. Everyday I see analysts calmly revising down their price targets by 25% and still recommending the companies as a "buy". A classic is Northern Rock which Goldmans price target for most of this year was £11.50. In September they lowered their target to £2.96 and today's share price is 83p with no comment from the analyst...

2:11 pm  
Blogger kinglear said...

WW- now you can see why its nothing personal with JF....

3:20 pm  
Blogger Winchester whisperer said...

I see that. He's a funny chap, isn't he?

3:21 pm  
Anonymous Ellee said...

I would love to understand finance more. Some woman in a networking group meet monthly and buy shares and I keep meaning to join them. Maybe it is not a good idea, too unpredictable.

6:47 pm  

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