Quick Fact: The relationship between GDP growth and Equity Returns

The relationship between economic growth and equity returns is much debated. Not so strange if you look at the graph below. From a distance the two certainly look related.

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However the next graph shows that, from a closer look, things look a little bit different. The graph reveals the correlation between the 1-year changes in real GDP growth and the 1-year stock real market return in the United States measured over different time periods. The results are pretty straightforward. The correlation, in each of these periods considered, is very close to zero. Therefore, the conclusion must be that there is hardly any (coincident) relationship between equity returns and economic growth at all.

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This leads to the obvious question if GDP numbers matter for stock markets at all? To find an answer to this question I calculated the correlations again but now with a 1-year time lag in the stock market return data. This way the forward looking nature of the equity market is taken into account. The results are shown in the graph below.

The results look pretty different from those in the first graph. The relationship is much stronger, especially since 1946. Since then the correlation tops 60% in every time period, and in the most recent period from 2003 onwards the correlation is a very impressive 84%. Hence, there is a statistical significant positive relationship between equity returns now and real GDP growth one year later.

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So, what does this mean for investors? Well, the last graph tells us that GDP growth numbers are not totally useless after all. You just have to use them in the right way. Simply, looking at the current GDP growth data and combine them with equity return expectations doesn’t get you far. But, being able to predict the GDP growth 1-year forward could be worthwhile. Now, forecasting GDP is by no means easy, but a solid indication on future GDP growth, will give you some clue about where equities are heading.

One response to “Quick Fact: The relationship between GDP growth and Equity Returns

  1. Helpful post, thanks. Would love to see what the data show withthe lag going the other way too (GDP at t-1, and Equity returns at t)

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