On Friday, CNN proclaimed the end of the "American Age." A report by the International Monetary Fund noted China's economy could outgrow the U.S.'s economy in as little as five years. The writer noted that other measurements of GDP don't show China overtaking the U.S. quite as rapidly, but that it certainly appears that it will happen. He concluded with "Whenever it happens, that day will herald a new dawn for China and the end of an age for America."
Any investing worry stemming from such an announcement is really unnecessary. Let's see why that's the case.
First, it's important to differentiate between information and value relevant information. In other words, if everyone else knows the information, it's not value relevant -- at least in terms of making investment decisions -- because the information is already embedded in prices. If you're reading it on CNN's Web site, you can be sure you aren't the only one who knows it. Thus, even if it had value at one time, it no longer does.
Second, the size of a country's economy doesn't tell you anything about future stock returns. When it comes to growth rates of GDP, there's actually a negative relationship between them and stock returns. Despite the conventional wisdom, faster growing economies tend to produce lower stock returns, as most of the benefits of the faster economic growth accrue to the citizens in the form of growth in real GDP per capita, not to investors.
And finally, here's supporting evidence specifically related to China. For the period 1993-2009, China's annual real GDP growth rate averaged more than 10 percent, but a U.S.-dollar-based investor would have earned negative returns over the 17-year period -- and that's not even accounting for inflation of 2.5 percent. While China's economy grew five-fold (and its citizens benefited greatly from that growth), U.S.-based investors in Chinese stocks actually lost money. Just imagine how much money you would have been willing to invest in China in 1993 if you knew its real economy would grew at double digit rates for the next 17 years. And now imagine how you would feel about the actual results, especially since the S&P 500 Index returned almost 8 percent a year over that period.
The story is even more compelling when you add Japan to the equation. Keep in mind that Japan has been mired in a two-decade slump, and China passed it as the world's second largest economy last year. During the same 17-year period, both Japanese large and small cap stocks outperformed Chinese stocks, returning about 2 percent and 1 percent per year, respectively.
This example should serve as another reminder to ignore most of what you read from the financial media, as most of it is nothing more than noise, designed to get your attention and make you worry so you turn to them to find out what you need to do. The same could be said when they start talking about how investing may be affected by:
- Revolutions throughout the Middle East
- A nuclear disaster disrupting the world's third largest economy
- The price of Brent crude oil surpassing $125 per barrel
- Standard & Poor's putting a negative watch on the U.S. Treasury's credit rating
- A collapsing dollar
- The battle over the huge budget deficits
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