For many of us there is a tendency to think that when the economy does well, the stock markets should do well. Right? Well, not so fast. There is too much evidence to the contrary. When the Chinese Economy was galloping at 8.5% p.a. its investors made only 1.7% p.a. When the American economy was crawling at 2% p.a. its shareholders earned 15% p.a. Exactly during that period. The UK Economy grew at 2% and their equity shareholders wealth grew at 6.3%.

How does this happen? I remember reading in The Economist about this being true over the decade of the 70s too…when this theory was back tested!

Why does this happen? well I do have some scholarly studies to fall back on – but let us just pick up the conclusion of the scholarly study: The report concluded that it “found no statistical link between one year’s GDP growth rate and the next year’s investment returns.”

Well, let us take the case of India. If you use Danth Kanti tooth paste, use Baba Ramdev soap and shampoo, biscuits from the local baker,  eat bread from a local bakery (or your wife bakes it herself), you buy a Motorola phone, a Samsung phone, a Haier Refrigerator, a Mitsubishi aircon, a Hyundai car and fly Indian airlines, your spending is not being felt by the market. It is just not visible to the market.

You eat out in a restaurant, you drink imported beer, your children drink Coke and Pepsi. You eat at McDonald, and Kentucky Fried Chicken. So that part of your ‘branded’ eating out and its margins are lost to the equity market.

The cash that you pay to the teacher for tuition, the cash that you paid to the caterer, the cash that you paid to the taxi driver – are all lost to the economy itself, so the market cannot capture it at all. The money paid to the grocer, vegetable vendor,…etc. is also lost to the market. Now consider a situation where GoI forces all companies wanting to sell in India to be listed in India – remember George Fernandez did that? then we will have Coke, Pepsi, Monsanto, Samsung, LG, Mitsubishi, …all being listed in India. This will dramatically change things – hey hold your horses, there is no such provision.

Growth economy stocks (like Growth company stocks) are always available at a high price – so what really works? What does work? Over the long run, it is valuation; the higher the starting price-earnings ratio when you buy a market, the lower the return over the next 10 years. Many fund managers must have told you this at various points in time. So if you entered the market when the PE of the market was 10, you will get the full impact of the growth – when the pe of the market goes to say 30. Eps growth + PE expansion is a deadly combination to ride.

Only problem for people like me is I do not have a portfolio in a currency other than rupee…maybe I should invest in SnP or Nasdaq. Developed markets are like Value buys, you can get decent dividend, currency appreciation, more scientific and better regulated markets and less volatility. So if your portfolio is about 1 Million US $, it is time to look at investing abroad – through a slew of funds available in India.