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...