Stock Market ≠ Economy

Economic statistics hit your inbox almost on a daily basis. Markit has its “flash” numbers ready 15 days before the “final” numbers. Government/RBI press releases about the GDP, CAD, etc come out once a month. And then there are expert forecasts about how the numbers are going to look on an annual basis, etc. And then there are bloggers and commentators who slice-and-dice the data to read the tea leaves. But should equity market investors care?

“An economist is an expert who will know tomorrow why the things he predicted yesterday didn’t happen today.” – Evan Esar

If you are not trading interest-rate or currency derivatives, and if you truly are a long-term equity market investor, then growth rates hardly matter. Data show that there is very little correlation between GDP growth and stock market returns. In a 2012 paper titled “Is Economic Growth Good for Investors?”, Jay R. Ritter from the University of Florida actually found a negative correlation between GDP growth per capita and inflation-adjusted stock returns. From the abstract:

Economic growth comes partly from increased inputs of capital and labor, which don’t necessarily benefit the stockholders of existing companies. Economic growth also comes from technological change, which does not necessarily lead to higher profits if competition between firms results in the benefits being passed to consumers and workers. Realized growth has both an expected and unexpected component. Apparently investors overpay for expected growth, and this over-payment more than offsets the benefits of unexpected growth.

“If you spend more than 13 minutes analyzing economic and market forecasts, you’ve wasted 10 minutes.” – Peter Lynch

In fact, seasoned investors have time and again advised us to keep economists away from the trading floor. Here’s a gem from TRB:

Stocks trade based on three things: sentiment, valuation and trend. Yes, economic data feeds into these things, but it is up to the trader or investor to determine their combined favorability, an economist does not do that sort of work. The reality is that there is no such positive correlation over various periods of time between economic data and stocks in any given country.

And recently from AWOC:

The economy and the stock market are two different animals. The economy matters much less to stock market returns than most professional investors would have you believe. Economic data lags, gets revised, has seasonality and is just generally hard to use when making investment decisions for all but a very small percentage of investment professionals.

I am all on board to keeping a 36,000 foot view on growth trends, credit cycles, bank balance-sheets etc. It allows you to develop an understanding of sector rotations and position your portfolio beta. But knowing the minutiae might actually be of negative value to your investment process.

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