GDP Growth and Stock Market Returns
Posted in Economic Indicators
January 8, 2009
In their Global Investment Returns Yearbook 2005, Dimson, Marsh and Staunton report that corporate profits do not represent a constant share of Gross Domestic Product (GDP). A rapidly growing economy does not necessarily generate commensurate growth in corporate profits, dividends and hence returns to investors. Since 1900, low-growth economies have superior stock market performance. “Historically, buying into equity markets with a high GDP growth rate has given a return that is below the return of markets with a low GDP growth rate.” They conclude that “there is no apparent relationship between equity returns and GDP growth.” Does this conclusion hold for the time series of U.S. GDP? Using quarterly seasonally adjusted nominal GDP data and corresponding S&P 500 index data for 1950-2008 (234 quarters), we find that:
The following chart shows seasonally adjusted nominal GDP and the S&P 500 index on log scales over the entire sample period. The growth rates are both roughly exponential and of similar magnitude over the long run, with the stock market exhibiting the greater volatility.
For a more detailed examination of the relationship, we compare quarterly changes in these two variables.
The following scatter plot relates quarterly change in the S&P 500 index and same quarter change in nominal GDP. The Pearson correlation and the R-squared statistic for the two series are 0.00, consistent with the country-level “no apparent relationship” conclusion by Dimson, Marsh and Staunton cited above. Note that final GDP data is not available for several months after the ends of quarters.
Might any ranges of the quarterly change in GDP be predictive of stock market returns?
The next chart offers a different perspective on the relationship between quarterly changes in the S&P 500 index and same quarter changes in nominal GDP, ordering the latter series from lowest to highest values over the entire sample period. The horizontal axis is therefore not time-sequential. The chart generally confirms the non-relationship shown in the above scatter plot, hinting only that very strong GDP growth may reliably coincide with strong stock market advances.
Can we tell whether GDP leads the stock market, or vice versa?
The final chart plots Pearson correlations between between quarterly changes in the S&P 500 index and quarterly changes in nominal GDP for various lead-lag scenarios. For example, the “0″ lead point matches the above scatter plot, for which the change in GDP and change in the S&P 500 index are for the same calendar quarter. The “-2″ lead point gives the correlation between quarterly changes in GDP and quarterly change in the S&P 500 index two quarters ago (i.e., stock returns lead GDP changes by two quarters). To test persistence of the correlations, we calculate them for the 1990-2008 subperiod, as well as for the entire 1950-2008 sample period. Results suggest that stock returns are a weak indicator of the quarterly change in GDP growth one to three quarters ahead. However, the quarterly change in GDP tells us practically nothing about future stock returns.
In summary, evidence indicates practically no relationship between quarterly U.S. stock market return and same quarter change in nominal GDP. Quarterly stock return is a weak indicator for change in GDP three to nine months in the future, but quarterly change in GDP does not predict future stock market movement.
