Jim O’Neill, chairman of Goldman Sachs Asset Management, rebuts the argument that euqity market performance is not correlated to GDP growth over the long term. O'Neill says:
• In theory, equity market performance should be linked to economic growth.
• In practice, however, various studies claim that there has been no correlation between GDP growth and equity returns over longer time spans.
• We argue that there are significant methodological and conceptual issues with looking at such correlations for a cross-section of countries over time and…
• …more importantly, the concept of forward-looking expectations is entirely ignored.
• We find that equity markets are a lead indicator of GDP growth and react strongly to expectations about the future.
• In general, the sensitivity of equity prices to future growth forecast revisions appears to be higher in the Growth Markets than in the advanced world.
• Recognising that equity markets price in future growth places a renewed emphasis on valuation, in addition to growth expectations and growth sustainability.
• Some current and prospective Growth Markets still have the potential for higher and more sustainable growth and upside growth surprises that are not yet reflected in equity valuations.