Th financial media often talk about the prospects for the stocks market as closely liked to the prospects for the overall economy. Is this right?
in a general way, yes
The most important investors in developed markets tend to be citizens, or at least residents, of the country in question. This is partly because doemstic securities are the ones individual investors feel most comfortable with and can easily get the most information about. It’s also partly because institutional investors like pension funds or insurance companies both want to match their domestic liabilities with domestic assets, and because they are most often legally required to do so.
When a country is booming, employment is high and wages are rising, money tends to flow into stocks. When times are bad, not so much. In particular, it’s been my experience as a global investor that stocks in high GDP growth countries tend to do better than very similar stocks headquartered in low GDP growth nations.
looking a little more closely, no
This is the easiest to see in Europe. Switzerland has annual GDP of about $650 billion. Germany’s is six times that. Yet, the two countries have stock markets of just about the same size. How so?
–the Swiss market is dominated by international pharma and financial companies. Only a tiny amount of their business is done in Switzerland.
–large chunks of Germany’s very important export-oriented industrial sector are unlisted. The German stock market leaders are banks, public utilities and the autos.
In neither case–tiny country with enormous multinationals, or big countriy without many domestice companies listed on the stock exchange-os there a strong relationship between economy and stock market.
–The US is the country where, thanks to the SEC, the most information about the geographical breakout of earnings is available. Slightly over half of the companies in the S&P 500 provide geogrpahical earnings data. If we assume that the structure of the rest of the index mirrors that of the reporting companies (a whopper of a leap, but I’m not sure what else we can do), then the earnings of the S&P break out about as follows:
US 50% of reported earnings
Rest of the world 25%.
–Large parts of the US economy, like construction/property and autos have minimal representation in the S&P 500. In the former sector, lots of companies remain private. In the latter, a lot of the activity is by foreign companies.
If we just look at likely GDP growth for the US in 2015, we’d probably be predicting a pretty good year for stocks. GDP may be up by 3% real, 5% nominal. Money will likely flow into stocks. The Fed will probably be careful not to rock the boat by raising interest rates too quickly.
However, we have two other issues to factor in:
–economic activity in the EU, Japan and emerging markets may not be so great and the dollar has been strong vs. foreign currencies. This may mean that US-domiciled multinationals may not look so good, especially after their foreign results are translated back into dollars.
–In addition, we have to consider how we can find publicly traded stocks that are tied to potential hotspots for 2015 growth.