It was a stretch to think that stocks could sustain the impressive momentum they displayed on Monday and Tuesday, and so it was that the Dow Jones Industrial Average (DJINDICES:^DJI) and the broader S&P 500 (SNPINDEX:^GSPC) were down today, both by roughly three-quarters of a percentage point.
The macro view: It just seems like such an easy investing rule: Higher growth means higher stock returns. But what appeals to our intuition isn't always true, particularly when you're dealing with multiple variables. Morningstar published an interesting piece today under a provocative title: "Economic Growth -- Great for Everyone but Investors?"
Growth companies don't always make the great stocks. Why? Valuation. Investors often overpay for earnings growth; once the growth is (more than) priced into stock values, one can no longer expect to earn above-normal returns. Those who bought Facebook (NASDAQ:FB) shares on the day the social-networking company went public found this out the hard way. It turns out that the same is true when looking at countries and their stock markets. Historically, the relationship between GDP growth and stock returns across countries is extremely weak -- nothing close to being strong enough to bet on.
Even a legendary investor like PIMCO's Bill Gross gets this wrong by assigning too much weight to economic growth as a determinant of stock returns. If you want to bet on different counties, instead of focusing on the economies you (and everyone else) think will grow fastest, you're better off looking for stock markets that are priced to reflect low expectations or, better yet, genuine pessimism (think Asian markets during the Asian crisis of 1998-99, for example). For example, Morningstar suggests looking at Russia, which, "as proxied by Market Vectors Russia ETF (NYSEMKT:RSX), is trading at a paltry 5.6 times forward earnings, making it the cheapest of any major emerging market."
Alex Dumortier, CFA, has no positions in the stocks mentioned above; you can follow him on Twitter: @longrunreturns. The Motley Fool owns shares of and has options on Facebook. Motley Fool newsletter services recommend Facebook. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.