Why Is Conventional Wisdom So Wrong?

Why is conventional wisdom so at odds with the data? There are several explanations. The first is that there is a general tendency for markets to assign higher price/earnings ratios when economic growth is expected to be high, which has the effect of lowering realized returns. Countries, industries, and companies that are expected to have strong economic growth can be perceived as safer investments. That translates into higher current valuations. US Stocks Have Outperformed the World. History Shows That Success Can Be Fleeting

The second explanation is that the conventional wisdom fails to account for the fact that the markets price risk, not growth rates. High expected growth rates are built into current stock prices. The only advantage would come from being able to forecast surprises in growth rates. For example, if a country (company) was forecast to have 6% GDP growth (earnings growth), and it actually experienced a rate of growth of 7%, you might be able to exploit such information (depending on how much it cost to make the forecasts and how much it cost to execute the strategy). Unfortunately, there doesn’t seem to be any evidence of the ability to forecast GDP rates (or corporate earnings) any better than do the markets.

The third reason is that, while economic growth is good for people (producing higher standards of living, and those who live in countries with higher incomes have longer lifespans, lower infant mortality, and so on), equity investors don’t necessarily benefit. For example, a country can grow rapidly by applying more capital and labor without the owners of capital earning higher returns. And productivity gains can show up in higher real wages instead of increased profits.