The Bureau of Economic Analysis, the official scorekeeper for US GDP, recently announced that real GDP for the US economy decreased at an annualized pace of 4.8% during the first quarter of 2020. As we all know, the second quarter is going to be far worse given that the Covid-19 crisis didn’t take hold in earnest until March. The current consensus among economists survey by the Wall Street Journal calls for GDP to decline at an annualized rate of 32% during the second quarter; some more pessimistic forecasters are anticipating a decline of great than 40%. Regardless of what the precise figure is, we are essentially a lock to see GDP down on a year-over-year basis as of the end of June. Perhaps counterintuitive to many, such an occurrence may actually be considered a good sign for stock market investors as negative prior-year GDP growth has actually historically been followed by comparatively strong future stock market performance.
The table below, from Renaissance Investment Management illustrates the relationship between past GDP growth and subsequent stock market returns. The table groups past GDP growth on a trailing four-quarters basis into buckets of negative growth, growth between 0-3%, growth between 3-5% and growth in excess of 5% and examines stock market returns over the subsequent 1, 2 and 3 years as well as the percentage of observations where positive returns were realized.
The data clearly demonstrate that stock market returns on average were actually higher over the following 1-, 2- and 3-year periods following a contraction in GDP than during any of the periods were past GDP growth had been positive. In addition, we can see that stock market returns were more likely to be positive after negative growth than they were following positive growth.
This data highlights two crucial aspects of markets for long-term investors: (a) markets are forward-looking and trade not on “good” or “bad” but rather, “better” or “worse,” and (b) mean reversion is powerful concept in investing as bad stretches for the economy and the stock market are often followed by comparatively strong ones.
Renaissance Investment Management: “Market Update-GDP Growth and the Stock Market.” April 2020.
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