Last month there was a media fanfare when UK GDP exceeded its peak in 2007. Does it matter? And what’s going on in the rest of the world?
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“Big Day For Britain” screamed the media last month. The event was UK GDP at last reaching pre-recession levels. Whoopee.
Obviously extraordinarily low interest rates have helped this extraordinarily weak recovery, in particular boosting the housing market (which you are enjoying in scale only if you live in London and the SE). But the UK does not exist in a vacuum.
Export-dependent Germany has seen a downward trend in exports since the Autumn, as world trade has stagnated. Germany will not be growing at all in 2015 (say SaxoBank), which will be the big European surprise. Unemployment in stagnating France has risen for 10 straight quarters, and surveys show that the country is beset by a deep gloom. Youth unemployment in Italy is still rising, currently at 43%, and they are now in recession. And this is before Russian sanctions and recession start to have an impact on European corporates, let alone the risk of Russia cutting off energy supplies
The latest US GDP numbers (“Growth Rebound”) appeared to be based on some extreme assumptions (which will be revised down) and inventory building (rather than sales of inventory). No headline hype can hide the fact that at this stage of a US recovery is typically more than twice what it is currently – this is the worst recovery in history. Wages are stagnant for most, and profit margins are already at record levels.
Asia might well be more resilient, but Chinese growth will inevitably be relatively weak for a few years as they go through a deep transition. Who knows what might happen in Japan where Abenomics represents the last throw of the dice (for a country with huge debt levels and a rapidly ageing population). India will not grow sufficiently, soon enough, to save the world.
But let’s pretend that the UK was truly an island, self sufficient in all things, with not a care for world events. Would that GDP number matter? No.
In a nutshell, past economic growth does not predict subsequent stock market returns. But the reverse is true – strong equity returns can predict future economic growth. This has been illustrated in a range of research, most famously in the Triumph of The Optimists book (2002, Dimson Marsh), and more recently in research from London Business School in 2010 and 2014.
This is because the stock market is a discounting mechanism, in particular building into prices the growth expected in the following 12 months.
The best predictor of stock market returns over the next 3-5 years is the valuation level when you buy. So if you believe markets are cheap just now you should buy the market. If you believe valuations are toppy (the U.S.?) sit on your hands. Ignore GDP numbers.