Does higher growth increase long-term stock returns? JPMorgan intervenes By Investing.com

In a recent note to clients, JPMorgan looked at the relationship between economic growth and long-term stock returns, with a focus on developed markets (DM) and emerging markets (EM).

In developed markets (DM), JPMorgan finds a clear link between economic growth and stock returns. A 1% increase in long-run real growth is associated with about 3% higher stock returns on average.

This boost comes primarily from higher earnings growth, with additional contributions from increased valuations and currency appreciation.

“Roughly half of the profitability impact of higher DM growth comes from higher earnings growth,” states JPMorgan. “A little less than half comes from higher valuations. The rest comes from the strengthening of the currency”.

Emerging markets, however, tell a different story. Here, the link between economic growth and equity performance is much weaker. JPMorgan points out that many EM equity markets are not as closely tied to their domestic economies as those in developed markets.

For example, stock market capitalizations in MEs are often only a fraction of GDP, compared to a much larger proportion in DMs. As a result, JPMorgan research finds “no relationship between forecast growth and actual returns” in emerging markets, challenging the hypothesis that faster-growing economies should deliver better stock market returns.

The report also addresses the practical challenges of using economic growth as a predictor for stock returns. Long-term growth forecasts are notoriously difficult to make accurately, and JPMorgan notes that there is often a significant gap between forecasted growth and actual returns.

“We see no relationship between forecast growth and actual returns. Real returns have no relation to recent past growth,” the report points out.

Despite this, the bank suggests that investors with strong beliefs about a particular country’s growth prospects may still consider incorporating those views into their investment strategies, albeit with an understanding of the risks involved.

JPMorgan’s analysis points out that while economic growth can be a useful indicator in developed markets, it is far from a guaranteed predictor of stock performance, especially in emerging markets.

The recommendation for investors is to approach growth forecasts with caution and take into account the broader factors driving market returns.

“Aware of the difficulties in forecasting long-term growth, the results suggest that it would still be reasonable for an investor to incorporate any strong views about growth or growth differentials into the asset allocation process.”