It’s Not the Economy Stupid

Despite our concerns for economic growth in the years ahead, which we discussed in more detail here and here, the implications for equity investors are hazy at best.  Let’s pretend for a moment that the broadest measure of unemployment, the U-6 unemployment rate which is rapidly approaching 20%, will not have a meaningful impact on economic growth.  We’ll also assume that the jobs lost in the mortgage, construction and real estate industry quickly bounce back and that extreme levels of household debt-to-income and mortgage loan-to-value ratios will not lead to additional stress in the period for the millions of unemployed. 


What does such a magical V-Shaped recovery mean for stock market returns?  Approximately nothing. 

The chart below from Crestmont Research presents the average stock market return and average GDP growth by decade and by secular bull/bear market cycle.  A quick glance at the data demonstrates that economic growth is not the primary driver of stock market returns.  On average, GDP growth during secular bear markets has actually been faster than growth experienced in secular bull markets – 6.9% growth during bears versus 6.3% growth during bulls.  At the same time, the DJIA managed to appreciate 14.6% annually despite the lower average growth rates of secular bull markets, while actually declining by 4.2% during faster growing secular bears. 

A closer inspection of recent market cycles provides additional evidence as well.  Economic growth averaged 6.2% over the course of one of the greatest bull markets in history – from 1982 to 1999 the stock market marched higher at a 15.4% annual pace.  But in the period leading up to this cycle, the market was essentially flat (from 1966-1981) while GDP growth was more than 50% faster and growing at 9.6% annually.  Similarly, in the 40s and 50s, GDP grew at 11.2% and 6.6% respectively, while returns on stocks during both decades were counterintuitive to say the least.  Faster growth translated to lower returns and vice versa.  The rapid GDP growth of the 40s translated into a 2.9% gain for equity investors while slower economic growth in the 50s resulted in 13% annualized gains for stocks. 

Contrary to popular belief, there is also virtually zero correlation between year-over-year changes in earnings and stock prices.  But it sure provides “sell side” strategists with plenty to argue about on CNBC. 

Stock-to-GDP Correlation

Source: Crestmont Research