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By Christine Benz | 09-27-2010 05:53 PM

Economic Growth Does Not Equal Market Growth

Substantial GDP growth in the emerging markets will not necessarily translate into outperforming capital markets, says Fran Kinniry of Vanguard's Investment Strategy Group.

Christine Benz: Hi, I'm Christine Benz from Morningstar.com. Emerging-market stocks have been on a tear over the past decade with annualized returns averaging about 10%. But are those returns sustainable?

Here to discuss that question with me is Fran Kinniry. He is principal in Vanguard's Investment Strategy Group.

Fran, thanks for being here.

Fran Kinniry: Thank you, Christine.

Benz: So this is a hot topic, Fran, emerging markets, we've seen a lot of investors gravitating to emerging markets. A question is, what should their expectations be for this asset class given the runup that we've seen over the past decade?

Kinniry: Well, you mentioned a 10% return over the last decade, and if you put that in perspective the U.S. over the same 10 years has had a negative return.

Benz: Right.

Kinniry: So you would hope that investors are diversifying internationally or in emerging markets for the diversification properties, but we're a little worried that it's a similar story that we've seen in the past, whether it would be technology or growth stocks in the late 1990s, that inventors may be just buying the performance.

Benz: Performance-chasing. So, when investors think about growth certainly they think, well, emerging markets are going to be where you need to be because the economic growth appears to be a lot stronger and the prospects appear to be stronger. But your firm has shown that economic activity does not equal market activity. So, can you talk about what you found there?

Kinniry: Sure, that's exactly right. We've looked at all metrics that you could possibly look at to try to give you a handicap edge on the forward-looking capital markets, and our findings were that GDP growth actually had zero correlation to future capital market expectations.

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