What Does GDP Growth Tell Us About Future Stock Returns?

What Does GDP Growth Tell Us About Future Stock Returns?According to the GDP estimate released by the Bureau of Economic Analysis (BEA) on June 28, annualized real US GDP growth was 0.9% in the first quarter of 2016—well below the historical average of 3.2%. Investors often try to draw conclusions about future market movements based on current news, and it’s hard not to wonder if below-average GDP growth has implications for your portfolio.

Market participants are continually updating their expectations of the future, including their expectations of future economic growth. They act on these expectations, which means the current prices of stocks and bonds are based on the market’s consensus assessment of all available information, including GDP growth. So the only thing that will cause prices to move is some new piece of information (which happens pretty much continuously).

Current prices already reflect the expected GDP growth prior to the official release of quarterly estimates. The movement we see in the markets is based on the difference between the consensus estimate of GDP growth and what it actually turns out to be. This difference—the new piece of information—is what moves the markets.

Since markets move so quickly, by the time most people hear about it, prices already fully account for the new information. A good way to check this intuition is to look at market returns following poor quarters for GDP growth.

Quarterly S&P 500 Index Returns January 1948 – June 2016

What Does GDP Growth Tell Us About Future Stock Returns?Sources: S&P Dow Jones Indices, Bureau of Economic Analysis. Past performance is not a guarantee of future results. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio.

As we can see from the chart, there wasn’t much difference. From January 1948 to June 2016, the average quarterly return for the S&P 500 Index was 3.0%. If we look at quarters following particularly bad quarters—those in the lowest 25% of GDP growth—the average return was 3.2%.

While it is higher, this is well within the range of normal, random stock movements. The data still doesn’t suggest that you can predict what the markets are going to do based on the announcement of last quarter’s GDP growth.

As I said before, stock returns are based on new information. The markets are incredibly good at quickly taking any new information, absorbing it, and adjusting prices to account for it. By the time any normal person hears about something on the news, the markets have moved on.

Until you’re able to predict the future, it’s impossible to guess which way the markets are going to move. As Yogi Berra said, “It’s tough to make predictions—especially about the future.”

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