Chasing global returns

<i>Photo-Illustration: Peter Riches</i>
Photo-Illustration: Peter Riches

Most share investors are convinced share prices rise fastest in countries with booming economies. But there is little relationship between economic performance and sharemarket returns.

Research has been building in recent years showing just how disconnected the two are.

The latest contribution comes from from the head of asset allocation at Boston-based fund manager GMO, Ben Inker. He says, if there is any relationship between GDP growth and share returns, it is negative.

That is, there are more examples of where higher GDP growth is associated with lower sharemarket returns than the other way around.

For example, during 1980-2010, South Korea had a GDP growth just above 6 per cent, with shares returning just over 3 per cent. During the same period, South Africa had GDP growth of just over 2 per cent with shares returning more than 9 per cent.

There are further examples, including in developed economies, where a similar relationship is observed and a fewer number of examples where high economic growth is associated with better sharemarket returns.

Other research, including that conducted by researcher Morningstar, has not been able to show any correlation, positive or negative, between long-run economic growth and long-run sharemarket returns.

So what are the reasons for share prices not necessarily growing along with GDP growth or even company profits, for that matter?

Inker says one reason could be that countries growing strongly generally have high rates of dilution of shareholders - where more shares are issued to the same number of shareholders, lowering the price of each share. Company managements issue more shares to raise capital to fund growth to take advantage of a fast-growing economy.

This can hurt shareholder returns enough to more than offset the higher profit growth associated with fast growth, Inker says.

Another reason raised by research into the topic is that large companies, particularly those in emerging markets, are part-owned by the state and are facilitators or champions for the wider economy. These companies may not be run solely for the benefit of shareholders.

Another reason is likely to be the globalisation of markets, says the head of investment-market research at Perpetual, Matthew Sherwood.

About half of the sales of US-listed companies are generated outside the US.

Of course, it is just not a US phenomenon, but is occurring on most sharemarkets of the world.

One of the effects of globalisation is to reduce the sensitivity of share returns to domestic economic growth, Sherwood says. Investing with a focus on capital gains is likely to be misguided anyway, he says.

During the 100 years before the early 1980s, income made up about 60 per cent of the total shareholder returns. Beginning in the early '80s much of the growth in share prices was assisted by companies gearing their balance sheets.

But with the GFC the ''leverage boom'' came to and end and investors are going to find capital gains harder to come by, Sherwood says.

In Sherwood's opinion, the 30-year period since the early '80s until the GFC was an aberration. Share investing has returned to the way it always was - where the larger portion of total shareholder returns comes from income rather than capital gains.

To be successful in the new environment, investors need to focus more on dividends as a source of return than capital gains, Sherwood says. That means investors need to favour companies with strong balance sheets and quality company boards and managements. Companies that meet these criteria are more likely to lead the market, he says.

This story Chasing global returns first appeared on The Sydney Morning Herald.