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BLOG: Stop worrying about GDP

Kit Klarenberg
Written By:
Kit Klarenberg
Posted:
Updated:
25/06/2015

Recently, Japan reported a much better-than-expected revision to its first quarter gross domestic product (GDP) figures. Judging by the bullish headlines in the financial press, many investors were toasting this news and a Japanese government official recently commented that the country’s economy is “returning to a growth orbit”. Does that mean that investors should be taking a closer look at Japan?

Not necessarily. While countries with rapidly growing economies might appear to be ideal places to invest, academic research looking at data over the past 100 years has shown that there is virtually no correlation between real per capita GDP growth and real equity returns. For example, even though Japan had the highest historical economic growth rate in the study, its equity returns were about half those of South Africa, which was the weakest economic performer.

How can this be? There are a number of reasons, but the key point to remember is that you can’t actually invest in the Japanese or South African “economy”. Whether you invest in individual shares or buy an index fund, you are ultimately investing in a collection of businesses rather than the economy as a whole. Your choice is also limited to companies that trade on the stock exchange, ruling out investments in potentially lucrative but privately-held businesses.

Japan provides a good historical example. Throughout the 1980s, Japan was the dominant economic success story of the day. Books on Japanese management methods lined the shelves and electronic gadgets made by the likes of Sony and Panasonic became ubiquitous. It would have seemed “obvious” to put your money in Japan—and many investors did.

But that’s precisely the problem. By the time Japan’s economic success was front page news, it was too late for investors to make money. If you had bought Japanese shares at their inflated valuations of the late 1980s, you would have lost money throughout the next decade.

Eventually (a mere 20 years later!) the pendulum had swung to the other extreme after Japan’s stockmarket bubble burst, its economy stagnated and investors had moved on to other more exciting growth stories, such as the BRIC countries (Brazil, Russia, India, China). While Japan’s economic prospects were certainly bleak in 2010-11, this too was “obvious” and it created new opportunities to buy shares of some Japan’s best companies at extremely attractive prices due to excessive pessimism.

The lesson from Japan’s experience is clear: one of the worst things an investor can do is to overpay for stocks on the basis of unrealistic expectations about the country’s economy. On the other hand, some of the best opportunities can be found amongst companies that are over-looked and under-valued because of a bearish consensus view of their local economy.

In all cases, remember that you are investing in companies, not countries. It is far more important to understand the fundamentals of those businesses and how they may or may not be affected by the economy rather than betting on “the economy” itself. There are plenty of reasons why Japanese shares might be worth a closer look today—but we’d suggest taking a “bottom-up” view rather than investing based on the latest GDP reports.

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