When growth goes nowhere, do stocks soar?

July 27, 2009

Jason Zweig has some eye-popping results from Elroy Dimson:

Based on decades of data from 53 countries, Prof. Dimson has found that the economies with the highest growth produce the lowest stock returns — by an immense margin. Stocks in countries with the highest economic growth have earned an annual average return of 6%; those in the slowest-growing nations have gained an average of 12% annually.

Is this a published result? Can anybody point me to the paper where Dimon finds this?

Zweig’s first explanation for the phenomenon makes no sense:

When you buy into emerging markets, you get better economic growth — but, at least for now, you don’t get in at a better price…

In other words, economic growth is high, but stock valuations are even higher… At year end, emerging-markets stocks traded at a 38% discount to U.S. shares, as measured by the ratio of price to earnings. Now that both markets have bounced back, emerging markets are at only a 21% discount. And make no mistake: They should be much cheaper than U.S. stocks, because they are far riskier.

It seems to me that if you get higher growth at a 21% discount, that clearly counts as “a better price”. Yes, emerging-market stocks are more volatile. But the impact of volatility on a market’s (or even an individual stock’s) p/e ratio is far from obvious.

Zweig does then come up with a better reason why high-growth economies might have lower returns: essentially, the future growth is coming from companies which either don’t yet exist or haven’t yet listed. But before I start trying to work out what’s really going on here, I would very much like to take a closer look at Dimson’s results. Because they seem improbable to me: which slow-growing countries can boast a long-run 12% annual return on stocks?


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