Many investors focus on real GDP growth while thinking about perceptiveness of investments to a particular country. And this is really strange approach as real GDP growth is
- real
- measured in local currency
while what investors care about is
- nominal returns
- measured in USD
The average expected equity returns over many years are normally expressed by the formula:
Expected equity return = Expected real GDP growth + Expected inflation + Expected dividends yield
If you want to measure it in $, you should add change of exchange rates.
The good explanation and data for this you can find in many articles in the internet. Here I will just quote Warren Buffet made to Fortune Magazine back in November 1999 right before dot com bust:
“Let's say that GDP grows at an average 5% a year--3% real growth, which is pretty darn good, plus 2% inflation. If GDP grows at 5%, and you don't have some help from interest rates, the aggregate value of equities is not going to grow a whole lot more. Yes, you can add on a bit of return from dividends. But with stocks selling where they are today, the importance of dividends to total return is way down from what it used to be.”
The key component in this equation like Buffet mentioned is nominal GDP growth while dividends returns nowadays are small and cannot cause big differentiation. If we take a look at Nominal GDP growth in USD for 20 biggest countries (by GDP in 2009) for the period of 2000-2009, surprisingly we will find that Russia was the first one, with China only the second and India the forth. This analysis also gives insight about the country which will be on radar of EM investors soon: Indonesia. I have already seen BRIIC abbreviation.
In many GDP growth discussions Russia was not even mentioned in the last five years. Some want to exclude it from BRIC. Why were investors so inconsistent using real GDP growth which was not even close for their ultimate goal – nominal $ returns?
Let’s also see what the reasons were behind so drastic differences between real and nominal GDP growth.
In many cases this was high inflation that secured leadership in nominal GDP growth like for Russia and Indonesia. In case of China and Euro zone countries it’s also devaluation of local currencies. It’s worth to mention that Russia was the only country out of this top-20 with negative population growth which ate 0.3% GDP growth annually.
