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Economic growth not related to stock market PERFORMANCE

Warren Ingram
Economic growth not related to stock market PERFORMANCE

Would it surprise you to know that there is almost no relationship between the way the economy grows and the stock market’s performance? If you are spending time worrying about the economy when making your investment decisions, it is likely that you are wasting your time.

Warren Buffett, in his most recent shareholder’s meeting, told investors that he has never made an investment decision based on what he thinks the economy is going to do. One of the greatest unit trust fund managers of all time, Peter Lynch, said, “If you spend 13 minutes a year trying to predict the economy, you have wasted 10 minutes.” This might seem surprising to most. It seems intuitive that investors must have a good “feel” for the direction of the economy because companies will either be operating with economic tailwinds or struggling with difficult conditions. If the economy is doing well, one would expect more opportunities to make profit, which should translate to rising share prices.

There is a great study by Holger Sandte, Chief Economist at WestLB Mellon Asset Management where he covers a range of topics about how share prices and the economy relate. The finding that interested me most was that there is absolutely no relationship between the direction of share prices and the economy.

I can partially understand this finding because the stock market is forward-looking, it is always trying to anticipate what is going to happen and therefore current prices are based on investors’ future expectations. In contrast economic data is always historic; it can only tell us what has already happened. If we believe that stock prices are forward-looking then it might make more sense to see if share prices relate to economic data from a later date? For example, if we review the direction of the stock markets from January to March and then compare the data with the economic growth from April to June? The study still could not find a meaningful relationship with this delayed comparison. In other words economic data is interesting but not relevant to equity investors.

Consumer Confidence is a totally different matter. According to Sandte’s study, there has not been a prolonged period of time where US consumer confidence and share prices have moved in opposite directions. If consumers are feeling confident it will translate into rising stock markets over time. The good news for investors is that Consumer Confidence is regularly measured and published in the US and many other countries around the world.  In South Africa, the well respected Bureau for Economic Research from Stellenbosch University, publishes the Consumer Confidence Index which you can obtain from their website - www.ber.ac.za. The survey has been done since the 1970’s and provides reliable insights into the general population’s thoughts about their own economic well-being.

It is quite concerning to note that SA consumer confidence dropped substantially from December 2012 to March 2013 and is currently at nine-year lows. This might not bode well for our stock markets unless things change to make South Africans feel more positive about their financial futures.

I think there is some merit for sophisticated investors to monitor consumer confidence but only as one of a few key indicators of what is happening in South Africa at the moment. However I would not rely on this as an absolute guide to our stock market’s long-term. Markets move so quickly that it is impossible to invest successfully by anticipating what people are going to feel or how they are going to spend in the short-term i.e. periods shorter than two years.

Most of us don’t have the time to research and monitor these indicators properly. It would be better to focus on buying the index or quality companies that can adapt to all economic conditions and to ensure that your overall portfolio of investments is sufficiently diversified to survive all market conditions.

Warren Ingram is an award-winning financial planner and respected personal finance commentator in the media. He is the co-founder of Galileo Capital and has been a financial planner for nearly two decades. He was the South African Financial Planning Institute’s Financial Planner of the Year in 2011. Warren is a regular guest on 702 Radio and Cape Talk’s The Money Show with Bruce Whitfield. In addition, he writes a monthly article for the Sunday Times and Moneyweb, as well as periodical articles for a range of other publications.

Warren’s book, Become Your own Financial Advisor will be published by Zebra Press in July 2013 and will also be available in eBook format.

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