Wednesday, September 3, 2008 0 comments ++[ CLICK TO COMMENT ]++

China: GDP vs Stock Market Return

How does China's stock market return match up against its economic performance? I took a look at the Shanghai stock market returns over the last 18 years versus the GDP. I used the information from Raymond Li's SeekingAlpha posting, along with the official GDP numbers I pulled from Chinability. All the numbers are for the years ending December 31st, except the 2008 numbers which are year-to-date and estimate. The following chart plots China's GDP growth rate against the Shanghai stock market return.



Not surprisingly for stock market veterns, there is practically no correlation between the two. The stock market has done very poorly when growth was strong in the early 2000's; conversely, the market has done well with slowing growth. One thing to keep in mind is that China's numbers are likely manipulated heavily by the government. Furthermore, the stock market is heavily regulated and was nothing like a free market in the 90's (even now it's closed off to non-qualified foreign investors and the currency is pegged to a narrow band against the US$.)

One might want to look at the second derivative of the economy (rate of change in GDP growth) but that is assuming a whole hoard of other things about the nature of the economic numbers. I think GDP growth is the cleanest way of looking at economic performance.

The conclusion from all this is never to invest based on economic performance. If this year closes as the consensus expects, we will end up with strong GDP growth of 9%+ for this year and likely next year, yet the stock market would be down significantly. Part of the reason, of course, is the fact that valuations were really high last year. Emerging markets are like growth stocks in that they go through huge booms and busts.

I think it's time to start looking at China--Jim Rogers is still bullish--but I wouldn't invest based on whether the economy is going to be strong or not. Instead, valuations are what matter, as always.

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