The end of 2014 saw equity markets wobble as investors pored over poor economic data from Europe and Japan, and as terms such as “disinflation” and “secular stagnation” started to appear more regularly in the investment lexicon.
 
However, history has shown that strong gross domestic product (GDP) growth does not necessarily translate into healthy investment returns. Equally, as investors, it shows us that we need not fear some of the gloomy scenarios noted above.
 
The link between GDP growth and investment returns (or lack thereof) has been examined extensively in the world of academia. Jay Ritter in his 2004 paper and Dimson et al in their 2002 paper both analyzed returns over the preceding century. Ritter says most investors believe that economic growth benefits shareholders. But his study finds that the cross-country correlation of real stock returns and per capita GDP growth is actually negative.
 
Growth does not equal profits.
Looking back over past decades, empirical illustrations of Ritter’s observations are easy to find. In virtually every corner of the world, higher savings rates have led to an application of new capital, resulting in economic growth. In the emerging markets, growth has been generated by the more efficient utilization of labor (mainly via urbanization, a phenomenon mentioned in virtually every developing-market strategy note). But that growth has not always translated into higher returns for the original owners of equity capital.
 
Fellow academic Jeremy Siegel did similar research over a shorter time period—from 1970 to 1997—finding the same negative correlation. One reason, he suggests, is that the largest firms on an exchange may be multinationals. Such companies’ profits depend on worldwide, rather than domestic, economic growth. This is certainly the case in the U.K., where two-thirds of FTSE 100 company profits are generated overseas.
 
So who’s reaping the benefits of economic growth?
Substantial shares of economic growth often also accrue to companies’ management and staff rather than to shareholders. Should you doubt this, ask any long-term investor in the investment banking industry—or read the weekly "How To Spend It" supplement in the Financial Times.
 
Ritter also emphasizes the importance of corporate governance. Poor governance is a plausible explanation for GDP growth failing to feed through to investor returns. Russia is a good example. Investors in the world’s largest kleptocracy only need to head to the marinas of Monaco and St. Tropez to see where much of the return from that country’s growth story ended up.
 
Ritter is not asserting that growth is bad—far from it. He cites a close correlation between higher per capita incomes and longer life spans and lower infant mortality. But he is reminding us that shareholders may not be the beneficiaries of this forecast growth. It’s a heads-up to investors—do your homework, and don’t assume that all this GDP growth will end up in your investee companies’ profit  and loss accounts.
 
Impact on our portfolios
This year, we will watch with interest the efforts of central bankers and legislators around the world as they continue to pull the levers of this massive monetary experiment, which is quantitative easing. As in 2014, there will undoubtedly be periods where investors believe and periods where they disbelieve in the efficacy of these policies.
 
And as ever, past performance is no guide to the future. But as Ritter and others argue, the performance of the economy in which a company is doing business may not be much of a guide either.

Richard Dunbar, Senior Investment Strategist, Investment Solutions at Aberdeen Asset Management.