JPMorgan’s Insight on Economic Growth and Equity Returns

In a recent note to clients, JPMorgan examined the relationship between economic growth and long-term equity returns, focusing on developed markets (DM) and emerging markets (EM).

Developed Markets (DM)

JPMorgan finds a clear connection between economic growth and equity returns. A 1% increase in long-term real growth is associated with roughly a 3% increase in equity returns on average.

This increase is primarily driven by higher earnings growth, with additional contributions from increased valuations and currency appreciation.

“About half of the return impact of higher growth in DM comes from higher earnings growth,” JPMorgan states. “Slightly less than half comes from higher valuations. The rest is from currency strengthening.”

Emerging Markets (EM)

In contrast, the relationship between economic growth and equity performance in emerging markets is much weaker. JPMorgan observes that many EM equity markets are not as closely tied to their domestic economies as those in developed markets.

For example, EM stock market capitalizations often represent only a fraction of GDP, while they are proportionately larger in DMs. As a result, JPMorgan’s research finds “no relationship between forecast growth and actual returns” in emerging markets, challenging the assumption that faster-growing economies should provide better stock market returns.

Practical Challenges

The report also discusses the practical obstacles of using economic growth as a predictor for equity returns. Long-term growth forecasts are notoriously difficult to make accurately; JPMorgan notes there’s often a significant gap between forecasted growth and actual returns.

“We see no relationship between forecast growth and actual returns. Actual returns are also unrelated to recent past growth,” the report emphasizes.

Despite these challenges, the bank suggests that investors with strong beliefs about a particular country’s growth prospects might still consider these views in their investment strategies, albeit with an understanding of the risks involved.

Conclusion

JPMorgan’s analysis indicates that while economic growth can be a useful indicator in developed markets, it is not a reliable predictor of equity performance, particularly in emerging markets.

The key takeaway for investors is to approach growth forecasts with caution and consider the broader factors that drive market returns.

“Being mindful of the difficulties forecasting long-run growth, the results suggest it would still be reasonable for an investor to incorporate any high conviction views about growth or growth differences into their asset allocation process.”