GDP Growth Doesn’t Equal Better Share Market Returns

One of the most common investing assumptions is that the fastest-growing economies must produce the best share market returns.

At first glance, it seems logical. If a country’s economy is growing rapidly, businesses should generate higher sales and profits, which should lead to stronger returns for investors.

However, decades of research tell a different story. Studies by leading investment academics have consistently found little correlation between a country’s economic growth and its long-term share market performance. In some cases, countries with the highest GDP growth have delivered relatively disappointing equity returns, while slower-growing economies have produced exceptional wealth for shareholders.

The reason is simple: investors don’t own the economy. They own businesses.

The Economy Is Not the Share Market

Gross Domestic Product (GDP) measures the value of goods and services produced within a country. The share market, however, represents a collection of listed companies.

The two are related, but they’re far from identical.

Many successful businesses are privately owned and never appear on a stock exchange. Meanwhile, many listed companies earn significant profits overseas. Australian investors, for example, own companies such as CSL, Macquarie and BHP, whose earnings are heavily influenced by global markets rather than Australia’s domestic economy alone.

As a result, strong economic growth doesn’t automatically flow through to shareholder returns.

Example #1: India Versus the United States

India has been one of the world’s fastest-growing major economies this century. Between 2000 and 2023, India’s economy expanded at an average annual rate of around 6% to 7%, while the United States grew at roughly 2% to 3% per year.

If GDP growth alone determined investment success, investors might expect India’s share market to have dramatically outperformed the United States.

Yet the difference in investment returns has been far less extreme than the difference in economic growth.

From 2000 to 2023, the S&P 500 delivered total returns of approximately 7% per annum in US dollar terms. Over a similar period, India’s Sensex Index generated returns of roughly 11% to 12% per annum in local currency terms.

Importantly, India’s economy grew around three times faster than America’s, but investors did not receive returns that were three times higher. Economic growth and shareholder returns simply do not move in lockstep.

Why? Because investor returns depend on factors beyond GDP growth, including profitability, dividends, corporate governance, competition and the valuation investors pay for shares.

Example #2: South Africa Versus Australia

Research has also identified historical examples where faster-growing economies produced lower shareholder returns.

Throughout much of the twentieth century, South Africa enjoyed stronger economic growth than Australia. However, Australian shares generated higher long-term returns for investors.

The difference came down to factors such as company profitability, dividend payments, capital allocation and starting valuations. In investing, the quality of businesses and the price paid for them often matter far more than headline economic growth figures.

Expectations Matter

Perhaps the most important reason for this disconnect is that share markets are forward-looking.

When investors believe a country has strong growth prospects, they typically bid up share prices in advance. Those expectations become embedded in today’s valuations.

For investors to achieve exceptional returns, reality must exceed expectations.

This is why exciting economic stories do not always produce exciting investment outcomes. By the time everyone agrees a country has a bright future, much of that optimism may already be reflected in share prices.

Focus on What You Can Control

For everyday investors, the lesson is straightforward.

Rather than chasing the countries with the highest GDP forecasts, focus on owning a diversified portfolio of quality businesses at sensible valuations.

Economic growth is certainly positive, but it is not a reliable predictor of future share market returns.

Successful investing is rarely about identifying the fastest-growing economy. More often, it comes from owning great businesses that consistently create value for shareholders over long periods of time.

Because when it comes to building wealth, it’s not the growth of the economy that matters most. It’s the growth in the value of the businesses you own.

General advice only. Before making any investment decisions, consider your personal circumstances and seek professional advice where appropriate.