Tuesday, January 05, 2010

Stock Markets & Economic Growth In The Long Run

This report reminds us that while U.S. (and European and Japanese) stock markets had a "lost decade" in the 2000s, so-called emerging market stock markets have produced good returns.

Most likely, this trend will continue for awhile. The reason for this is that growth capacity is much stronger in China, India and other emerging economies than in the U.S., Europe and Japan.

Low investments and more statist policies will drag down the U.S. economy even more during the coming decade than in the preceding, something which is also true for many European countries. For Germany and a few other European economies and even more so Japan, demographic factors will further limit growth as both the supply of labor and capital shrinks as populations shrinks and ages.

China, India and other emerging market economies have far better structural prospects, something which means that stock market returns will likely also be better in the long run, though many faces a significant risk of short-term corrections given the current inflationary conditions created to compensate for loss of exports.

Some might argue against this link between economies and stock markets because companies are far more globalized in the past, meaning that U.S., European and Japanese companies can prosper even though their economies stagnate. But while that weakens the link, it does not end it. Higher economic growth is usually associated with the emergence of highly competitive domestic companies that challenges companies from slower growing economies, something which reduces the extent to which companies from slow growing economies can grow faster than their economies.

One good example of this is the Japanese stock market which has been weak for two decades despite the multinational nature of many of its companies. While Toyota and a few other Japanese companies have performed much better than the overall Japanese economy, other Japanese companies have lost market share in foreign markets (and perhaps also market share in the Japanese market) due to the emergence of tougher non-Japanese competitors.