And some things that look so wrong turn out to be so right.
Case in point. Investing in Europe now is a really bad idea, right? Why would anyone invest in Europe with the sad state of the European economy?
It turns out there is no reliable correlation between investor returns and the economic growth rate in a particular country. In fact, some researchers claim there is actually a negative correlation, meaning the higher the level of economic growth, the worse stocks perform.
“Looking at 83 countries over 110 years, we find no evidence that investing in growth economies produced superior returns,” conclude researchers at Credit Suisse. On the contrary, they claim, an investment strategy of investing in countries that have shown weakness in economic growth has historically earned higher returns.
How can that possibly be? Theories abound.
- Investors tend to overpay for stocks in rapidly growing economies, which ends up denting returns (similar to what happens to people who invest in rapidly growing, soon-to-bubble sectors like technology or real estate).
- As companies battle it out during periods of high growth, many get knocked out of the race, causing investors to lose money.
- While economic growth is analogous to sales, stock returns are akin to corporate profits. There may be a high level of economic activity in a country (sales) but that doesn’t mean those sales translate into high profits (stock returns).
- We shouldn’t confuse a nation’s economy with a nation’s companies. Global giant Nestle just happens to be based in Switzerland, part of troubled Europe, but it earns revenue and transacts business with consumers across the globe.
- Faster economic growth does not lead to higher stock returns. But higher stock returns do seem to be a leading indicator of rebounding economic growth.
That means we need to be careful relying on what we “know” about investments. “Investors who “know” that European stocks are doomed are probably fooling themselves,” say analysts with Morningstar’ ETF Investor publication. European stocks sport higher dividends than U.S. companies, averaging a healthy 4% dividend yield compared to the U.S. 2% yield. Euro stocks trade at lower valuations than U.S. stocks, meaning you get a better value for your money. Small wonder Morningstar predicts that investing in leading blue-chip European names may translate into better returns for investors.
The moral of the story? Don’t be in a rush to dump all of your international stock holdings. “It is possible to find companies that have excellent investment potential in countries where GDP is growing rapidly or slowly,” say investment managers at Virtus. There’s a place in every portfolio for an “unloved” but cheap asset, especially one that continues to pay out a healthy income flow, caters to consumers far beyond its own borders, and costs far less than its competitors across the pond.
Here’s an interesting smorgasbord of articles for those wanting to read further. See, for example, Gregg Fisher in Forbes, research by mutual fund company Virtus, academic research by University of Florida’s Jay Ritter, and Credit Suisse Global Investment Returns Yearbook 2010 for a discussion of the link (or lack of it) between economic (GDP) growth and investment returns.