Previously on Forbes.com I wrote an article critical of a newsletter from John Mauldin in which he questions the link between growth and stock performance. The article uses work by a prominent money manager named Jeremy Grantham. It appeared that Mauldin was recommending Grantham’s work.
Since then Mr. Mauldin has written to me to offer clarification, pointing out that he does not necessarily agree with everything he publishes in his columns. Though I’ve asked Mr. Mauldin several times asking him to state whether he DISAGREES with the theory that economic growth and performance are unrelated, he did not. So leaving aside the unresolved issue of whether this columnist is disagreeing with Mauldin or Grantham or both, the notion that growth and stock valuations are unrelated is an idea worth rebutting no matter who holds it.
One of the cognitive distortions which must be dealt with first, though, is the one which knocks down the straw man who says that economic growth precedes rises in stock market valuation. If one looks at a chart which shows the relationship between economic growth and stock market valuations one year later (and we happen to have one on hand), one sees that such an approach is worse than useless as a tool to anticipate stock market valuations; in fact it sends out a false signal, showing a small positive relationship between economic growth and future risk premiums in the stock market.
Not only are the correlations much more poor at 3.6%, but the slope of the line is wrong. If investors were paying attention to growth a year ago, then there would be an inverse relationship between risk premiums and growth. But the data above to the small degree that they show any relationship at all, show the opposite relationship.
Why is that?
Because stock and bond investors are always trying to look into the uncertain future and assess the risks and rewards associated with growth, shifting resources back and forth between fixed income and co-ownership, as they anticipate either bust or boom respectively. Please note the word ‘anticipate’ in the prior sentence. Equity risk premiums are much more a matter of anticipated future growth differentials then they are of past or even present.
NEW TIME Today, at 9:30 AM PT: Get the Market Movements in Advance: William's Edge Webinar for January 30th, 2014 | John Ransom
NEW TIME Today, at 9:30 AM PT: Get the Market Movements in Advance; Williams Edge Webinar for January 26th, 2014 | John Ransom