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Economic growth and earnings

The absence of a link between economic and corporate earnings growth has often disappointed investors in emerging markets. Reasons for this vary by country and are not unique to emerging markets. For example, Switzerland has a 20-year correlation between GDP and earnings growth in the following 12 months of –0.56, implying that as GDP growth rises, earnings fall and vice versa.1

The reasons for this reflect the stock markets concentration of large multinational companies in the financial, industrial and pharmaceutical sector, with limited influence from domestic growth drivers.

There is a clear relationship between GDP and earnings growth in India, the correlation is 0.62 over the same time period.2 This implies that Indian economic growth translates well to earnings growth in the following 12 months. This is the highest correlation among large emerging markets. Among sectors, the highest correlation between Indian GDP and earnings growth is energy, followed by industrials and materials.

Correlation Between GDP and Earnings Growth Over 20 Years

As of September 2023

Source: Franklin Templeton, Bloomberg, MSCI.

If policymakers in India are successful in raising GDP growth to an average of 7% in the coming decade, this can be expected to follow through to corporate earnings. While there will inevitably be economic mini cycles over this period, rising earnings growth would ordinarily be expected to attract capital to the market and support valuations.

Assuming no expansion in valuation multiples and the equity market tracks earnings growth, we believe an investment case can be made for significant long-term capital gains in the Indian equity market.

Endnotes

  1. Source: Franklin Templeton, Bloomberg, IBES, MSCI.
  2. Ibid.

 

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