After all the huffing and puffing of the election, the
fiscal cliff, and the Dancing With the Stars season finale, the U.S. stock
market ended the month of November within 0.3 percent of where it started, according
to The Wall Street Journal.
Although the return for the month was basically flat, a
chart of the daily returns looked more like a healthy man’s EKG. From the
closing high of the month to the closing low, the S&P 500 dropped 5.3
percent. Then, from that closing low to the last trading day of the month, the
index rose 4.6 percent, according to data from Yahoo! Finance.
Overseas, the markets jumped around, too:
·
In Europe, the Stoxx Europe 600
index rose 2.0 percent on the month – its sixth monthly gain in a row.
·
In China, the Shanghai Composite
index fell 4.3 percent in November and is now down about 10 percent for the
year.
·
In Japan, the Nikkei Stock Average jumped
5.8 percent on the month to close at a seven-month high.
Source: The Wall Street Journal
What’s happening in Japan is rather interesting. The country
will hold an election later this month to elect a Prime Minister. The leading
candidate, Shinzo Abe, recently said the Bank of Japan should pursue a policy
of unlimited bond purchases and zero-to-negative interest rates in order to rev
up the moribund Japanese economy (sounds like the U.S.!). Abe’s easy money
policy rhetoric helped lead to a roughly 10 percent drop in the value of the
Japanese yen against a basket of developed market currencies between June and
November 19 of this year and helped propel last month’s 5.8 percent rise in the
Japanese stock market, according to Bloomberg and The Wall Street Journal.
As last month’s results show, we live in an interconnected
world with many moving parts. Even something as simple as a Japanese Prime
Minister candidate promoting an easy money policy can move markets
dramatically.
ARE STOCK MARKET RETURNS CLOSELY RELATED TO the overall level of growth in
the economy? Logically, it makes sense to think as the economy grows, so will
stock prices, and vice versa. Let’s test that hypothesis using historical data.
The following table
compares the return in the stock market during three different time periods to
economic growth during those periods. Two of these periods were weak times for
the market and one was strong. They are compared to real growth in the economy
(i.e., after removing inflation) and to nominal growth in the economy (i.e.,
with inflation included).
|
Period
|
S&P
500 Annualized Return
|
Real
GDP Growth
|
Nominal
GDP Growth
|
Market
Cycle
|
|
1966 - 1981
|
1.7%
|
3.0%
|
9.6%
|
Weak Period
|
|
1982 - 1999
|
14.6%
|
3.3%
|
6.3%
|
Strong Period
|
|
2000 - 2008
|
-6.2%
|
2.3%
|
4.8%
|
Weak Period
|
Sources: Bureau
of Economic Analysis, Yahoo! Finance
Note: S&P
500 returns exclude reinvested dividends
Here are some
conclusions from the table:
1.
Economic
growth – after removing the effect of inflation – has remained remarkably
stable at 2.3 percent to 3.3 percent during extended strong and weak market periods
dating back to 1966.
2.
Stock
prices can rise or fall dramatically during extended periods of time regardless
of what’s happening to underlying economic growth.
3.
The
high inflation period from 1966 to 1981 – as shown by nominal GDP growing 9.6
percent versus real GDP growing 3.0 percent – did not help stock prices as the
S&P 500 index only rose 1.7 percent on average per year excluding
reinvested dividends.
4.
A
combination of strong stock market returns from 1982 to 1999 (which raised
market valuation to an extremely high level) and somewhat slower economic
growth helped cause stock market returns from 2000 to 2008 to be quite
negative.
5.
The
change in the rate of inflation or disinflation can have a major impact on
stock market returns.
This table is a
great example of why it’s so important to do research. The logical thought that
stock price movements mirror changes in economic growth is not supported by
data going back to 1966.
Just like you can’t
judge a book by its cover, you can’t always evaluate the stock market by taking
logical ideas at face value.
Weekly Focus – Think About It…
“Reason itself is fallible, and this fallibility must find a
place in our logic.”
--Nicola
Abbagnano, Italian existential philosopher
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