Moving towards the mainstream

Stock market development and performance
in the rapid-growth markets

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Trends in equity returns

The last decade: Rapid-growth markets (RGMs) experience impressive growth and offer outstanding equity returns

The EM economies, and in particular the RGMs, had a breakout period last decade, in terms of both growth and equity returns.

Over the past 12 years, the MSCI Emerging Markets Index has beaten the annualized return of the MSCI World Index by 4.6% (6.2% versus 1.6%).1

The difference in returns, compounded over this period, would have been considerable.

This one-sided performance by RGM equities, and EM equities more broadly, reinforced the belief that, although these stocks could be volatile, holding them over sufficiently long periods would yield superior returns as long as the developing economies were growing faster than their developed counterparts.

Little correlation between GDP growth and equity returns

It may seem obvious that owning equities for many years in rapidly growing economies would yield strong returns, but there has been no correlation between economic growth and equity returns over long periods.2

RGMs average annualized equity returns 2000-12


Source: Bloomberg, 2012

  • The claim that real dividends grow at the same rate as real GDP does not hold.
  • With a correlation of -0.23, the supposedly strong positive correlation between long-run real growth in per capita GDP and real equity returns is non-existent.2

As our table highlights, in the last decade, there was little correlation between per capita GDP growth and average annualized returns among most of the RGMs.3

Economic growth and equity returns (2000–11)

Country GDP growth per capita Annualized equity return (%)
China 9.6 8.3
India 5.6 15.6
Russia 5.6 24.5
South Korea 4.1 7.2
Indonesia 3.8 21.4
South Africa 2.6 12.5
Colombia 2.5 29.1
Brazil 2.0 13.6
Mexico 0.9 16.7

Source: Bloomberg, 2011

 

Returns, dividends and GDP growth, 1900–2010



Source: Credit Suisse Global Investment Returns Yearbook 2010, Credit Suisse Research Institute, 2010 (author’s calculations).


Why rapid economic growth does not always produce excellent stock performance

  • Growth in a country’s real economy is not the same as growth in its stock market capitalization.
  • Growth in market capitalization may not provide investor returns.
  • Global investors are often unable to share in EM returns because EM companies may be largely offset to foreign investors.
  • In many EMs, there are still significant restrictions on which shares foreigners can own.
  • There may be no clear correspondence between a company’s place of origin and its economic exposure. EM companies trading internationally may be dependent on growth in the developed world.
  • If there is a consensus that EM growth will be higher, then this should already be reflected in stock prices. It is highly unlikely that investors’ expectations have not already been fully reflected in EM stock prices.

Emerging market equities outpace developed markets, but only when EM economies are growing faster

It would seem there is no link between economic growth and stock market performance. But is this conclusion too simple?

The performance of EM economies has varied enormously over the past three decades, alternating between stable growth and severe crises, but a closer look reveals a more subtle pattern.

While it is true that long-run returns have been greater for investors in EMs, there has also been enormous variation in returns from the developing world over the last 25 years.

Contrasting stock returns 1988–2012
(Based on US$100 invested in December 1987)



Source: Bloomberg, 2012, Note: through May 2012

Over the last 25 years EM equities have always outperformed mature equities when developing economies were growing faster than developed markets — and they have underperformed when the reverse was true.

Spectacular EM stock returns are tempered by greater market volatility

With the origins of the recent financial crisis in the developed world, however, relative risk perceptions have been changing.

Some analysts believe that, with many of the developed economies coming out of the crisis with significant private and public debt levels, EMs might now be relatively less risky; for the first time, all BRIC countries currently have investment-grade sovereign debt ratings.

During the past decade, however, the price-to-earnings ratio gap between emerging and developed markets has largely disappeared.

Since the 1980s, EM equity returns have been much more volatile than equity returns in the developed world: holding a diversified EM stock portfolio may have paid handsomely last decade, but the investor paid a heavy price in terms of volatility.

EMs remain hypersensitive to global economic conditions

Their market beta over this period was 1.3 — i.e., EM returns were around 30% more volatile than those recorded on the MSCI World Index.

 

Returns, dividends and GDP growth, 1900–2010
Returns, dividends and GDP growth, 1900–2010×

Source: Credit Suisse Global Investment Returns Yearbook 2010, Credit Suisse Research Institute, 2010 (author’s calculations).

Contrasting stock returns 1988–2012
Contrasting stock returns 1988–2012 ×
Source: Bloomberg, 2012, Note: through May 2012

1.The MSCI Emerging Market Index is a free float-adjusted market capitalization index designed to measure equity market performance in the global EMs; “free float- adjusted” implies the actual return foreign investors would receive given the numerous restrictions on foreign ownership. The MSCI World Index is a market-weighted index composed of companies representative of the market structure of 22 developed market countries in North America, Europe, and the Asia-Pacific region.

2.See Jay Ritter, “Economic Growth and Equity Returns”, Pacific-Basin Finance Journal 13, 2005, pp. 489–503.

3.Ritter, p. 15.

4.In fact, for all 25 RGMs, the correlation coefficient was positive but only 15%.

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