Growth Just Part Of The Investment Story

May 20, 2015

This article is part of a regular series of thought leadership pieces from some of the more influential ETF asset managers in the money management industry. Today's article is written by Michael McClary, chief investment officer of Akron, Ohio-based ValMark Advisers, which markets the “TOPS” brand of asset allocation models.


As professional portfolio managers, we often remind ourselves to focus on the climate and not on the weather. Our portfolio strategies focus on providing appropriate investment results over a longer time horizon (climate), recognizing that if we operate within the constraints of the climate, we will be able to enjoy the good weather and endure the bad.


We find many investors we speak with tend to focus primarily on the weather, instead of keeping their eyes on the climate. So, to be specific about this climate versus weather metaphor, we tend to favor broader funds such as the Vanguard FTSE Emerging Markets ETF (VWO | C-85) that tap into the global investment climate rather than a more finely targeted security.


The Stock Market Vs. The Economy

In this article, we will explore another topic that can be confusing: the relationship between economic growth and short-term stock market performance. Intuitively, people would want to invest in countries experiencing relatively high economic growth. Why shouldn't you be rewarded with cash return on investments in countries doing well economically?


Similar to the relationship between weather and climate, economics and stock markets are interrelated. There’s little question that economic success or failure and long-term economic trends can have a profound impact on long-term stock market results for a particular country.


Likewise, we often observe how sudden surprises in economic numbers can help to produce short-term market swings. However, it’s important to note that relatively long cycles can occur where countries with lower economic growth rates may outperform countries with higher economic growth rates.


The US And China Example

As an example, the table below shows the relationship between GDP growth in China and the U.S. and their respective annual stock market returns in the last 10 years:



  China GDP Growth YOY Hang Seng Return US GDP YOY S&P 500 Return
31/12/2014 7.36% 5.17% 3.88% 13.69%
31/12/2013 7.75% 6.31% 3.74% 32.39%
31/12/2012 7.76% 26.74% 4.16% 16.00%
31/12/2011 9.30% -16.96% 3.70% 2.11%
31/12/2010 10.41% 8.20% 3.78% 15.06%
31/12/2009 9.21% 55.79% -2.04% 26.46%
31/12/2008 9.63% -45.64% 1.66% -37.00%
31/12/2007 14.20% 42.49% 4.49% 5.49%
31/12/2006 12.68% 38.19% 5.82% 15.79%
31/12/2005 11.30% 8.20% 6.67% 4.91%
5-Year Growth/Return 8.51% 4.95% 3.85% 15.45%
10-Year Growth/Return 9.94% 8.67% 3.56% 7.67%

Source: Bloomberg


The U.S. and Chinese markets were chosen as they represent markets familiar to many investors. The U.S. and China also reflect two economies that have had a relatively consistent and wide gap in economic growth rates. We chose the Hang Seng index to represent a market that is investable to all global investors, as opposed to the restricted onshore Chinese markets.


We recognize that other time periods and markets could be chosen to show positive relationships between economic growth and stock market returns. We could also have chosen time periods that show even stronger divergences between GDP growth and market returns; for example, China’s GDP growth averaged +9.2 percent-plus from 2000 through 2004, but the Hang Seng return was basically flat.


A few observations from the data are:


  • The Chinese economy has consistently grown at a rate more than double that of the U.S. during the time period shown.
  • In the trailing five-year period, U.S. stock market returns have nearly tripled that of China.
  • In the trailing 10-year period, Chinese returns outpaced that of the U.S.; however, by a margin much slimmer than the GDP difference would portend.


An investor who overweighted the Chinese market simply due to a higher economic growth rate during these time periods rightfully could be disappointed in China’s stock market results.


This is one of the reasons investing in individual-country ETFs, such as the SPDR S&P China ETF (GXC | C-35) or the iShares China Large-Cap ETF (FXI | B-47), and expecting broad market results, can sometimes lead to disappointment.


We generally prefer to use the Vanguard FTSE Emerging Markets ETF (VWO | C-85), for example, to gain broader exposure to the “climate” impact of longer-term growth in emerging market economies and stock markets. We may then use individual-country ETFs only for specific targeted exposure.


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