CHAPEL HILL, N.C. (MarketWatch) — Is the U.S. stock market living on borrowed time?
It certainly seems that way, given such serious threats to global economic growth as another government shutdown and a no-deal Brexit. During the last government shutdown, for example, the S&P 500 Index
rose by more than 10%, even as Kevin Hassett, the chairman of the Council of Economic Advisers, was estimating that the shutdown was reducing U.S. economic growth for the quarter by 0.13 of a percentage point for each week of the shutdown.
And, now, yet another shutdown appears imminent.
No one is saying the economy doesn’t matter — the relationship between it and the stock market is complex.
There is an even bigger potential threat, furthermore, from the prospect of a no-deal Brexit. One pessimistic forecast suggests that exiting without a deal could lead to a 9.3% contraction in the U.K. economy and cause housing prices to drop by 30%. That excludes the corollary impact on the European economy and that of the entire world.
However, it’s perhaps not as big a surprise that the stock market has been so strong in the face of such undeniable threats. That’s because the relationship between equities and the economy is not as straightforward as we might otherwise think.
Two investing studies
Consider an academic study published in 2012 by Jay Ritter, a finance professor at the University of Florida, titled “Is Economic Growth Good for Investors?” For the stock markets of both developed and developing economies, he found that, historically, there has been a negative correlation between inflation-adjusted per-capita gross domestic product (GDP) growth and stock market returns.
You read that right: Negative.
As Ritter notes, his finding “means that investors would have been better off investing in countries with lower per-capita GDP growth than in countries experiencing the highest growth rates.”
Having a hard time swallowing this counterintuitive conclusion?
Consider another study conducted last summer by Vincent Deluard, head of global macro strategy at INTL FCStone, a New York-based financial-services firm. Deluard set out to measure how much money you could have made in the stock market if you knew one quarter in advance what the final GDP growth rate would be for that quarter. He constructed a hypothetical portfolio that was 100% invested in equities if the subsequent quarter’s GDP growth was higher than in the preceding one, and otherwise 100% in cash.
Believe it or not, this hypothetical portfolio lagged a buy-and-hold strategy by 1.0 annualized percentage points from 1948 through early 2018.
Deluard turns to the Greek myth of Cassandra to explain what this finding means for investors: “Foresight is a curse when Gods control humans’ fate.”
To be clear, no one is saying that the economy doesn’t matter. It’s just that the relationship between it and the stock market is complex and largely inscrutable.
The bottom line? Just as investors “spend far too much time worrying about the next recession,” as Deluard puts it, they are putting too much importance on whether there is another government shutdown, how long it lasts if there is one, or how Britain muddles through Brexit.
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