Flash: Rich Countries Do Not Have The Best Stock Market Performance

Contrary to what you might think, new research shows that rich countries do not have the best stock market performance.
Elroy Dimson, Paul Marsh, and Mike Staunton, researchers at London Business School, research this odd phenomenon.

This is what they had to say:

The first explanation is of course that stock prices impound anticipated business conditions. As we showed in our 2010 paper, although past economic growth does not predict subsequent equity market movements, stock prices do predict future economic growth.

Markets anticipate the macro-economy. To use public information to try to predict the market is to bet against the consensus view set by a multitude of other smart and informed global investors.

Secondly, a strategy of buying the shares of countries that are advancing economically is a strategy of buying companies that are on average becoming less risky, and hence offer a lower expected return.

It is more risky to invest in companies in distressed economies. Other things held constant, the expected return on equities in successful, growing economies should therefore be lower than the expected return in declining economies.

Third, there may be limits to arbitraging global mispricing. There is extensive evidence that investors bid up the prices of growth assets, to the point that their long-run return is below the performance of distressed assets (sometimes referred to as ‘value’ investments). Some observers regard this as mispricing, and contend that it offers opportunities for arbitrageurs.

The strategy would be to buy equities in distressed markets and to short-sell securities in fast-growing markets. However, short-selling can be costly and risky, thereby allowing ‘hot’ markets to remain overpriced, and to yield disappointing long-run returns.

Last, there is the question of luck. Some countries have resources — agricultural, extractive, capital, or intellectual — that may confer an advantage compared to other nations. If that advantage is appreciated and already priced in by investors, there can be no expectation of superior investment returns. But if the consensus undervalues those resources, then an astute or lucky investor may outperform.

In the 20th century, resource-rich countries like the U.S., Canada, Sweden, or Australia prospered. In the opening decade of the 21st century, commodity-rich and low-labor-cost emerging markets prospered. Some of the successes and disappointments may be attributable to Fortuna — the goddess of luck.