NBIM DISCUSSION NOTE 5-2012 30 MARCH 2012
Economic Growth and Equity Returns
We study the links between economic growth and equity market returns to evaluate whether structural changes to global growth composition have implications for longer-term strategic allocations. In particular, we assess whether the projected rise in emerging markets’ share of the world economy warrants an allocation to emerging asset markets that deviates from market weights.
- Growth prospects are better in emerging markets than in developed countries for some decades to come due to favourable demographics and healthier public finances.
- The theoretical case for a positive relationship between economic growth and equity returns can be inferred from neoclassical growth theory.
- Finance theory, in particular an international version of the Capital Asset Pricing Model, emphasises the role of a market’s covariance with the global portfolio, and not economic growth, as the main driver of expected returns.
- Restricted capital mobility or market segmentation could explain deviations from the international CAPM. Political and governance risks are also potential factors in determining expected returns.
- Empirical evidence in developed and emerging markets does not support the notion of a structural relationship between economic growth and equity returns. The two main reasons are: (a) some countries are better than others at converting GDP growth into profit growth, and (b) better growth prospects are often reflected in market prices.