The U.S. or Global GDP Growth: What Really Drives S&P 500 Earnings Growth?
In 2013 I had a research paper “Understanding the S&P 500: This index offers a Lot of International Exposure”, published in Journal of Investment Consulting [see * and ** in footnotes]. It used data from 2000 – 2010 to show that a large (~40%) and increasing fraction of the S&P 500 earnings were from international markets. It is important to note that it is not the level of earnings but the growth in earnings that drives stock returns, particularly in the longer run. In the long run, earnings growth is the biggest driver of stock returns, unlike valuation change which is a bigger driver over shorter horizons. The research showed that international/non-U.S. economies were accounting for the vast majority (~80%) of the global economic growth during the 2000 – 2008 period. Not surprisingly, on average ~40% of the earnings growth of the S&P 500 was from international markets, with the figure rising to as high as 60% in some years.
The implication pointed out was that an investor in S&P 500 is actually holding a globally diversified portfolio, and not really just a U.S. focused portfolio. An investor in S&P 500 derives the benefits of high growth in emerging markets like Asia and Latin America. At the time of this research publication, this international exposure and the high beta to global growth was not commonly understood to be a key driver for the earnings growth of the S&P 500 (a supposedly U.S. focused index), and by extension for S&P 500 returns. In fact, the data point of international exposure for the index constituents was not commonly available on platforms like Factset till a few years later (for the research paper I had gone through Compustat, Bloomberg, and 10-Ks).
It was hence very heartening to see the conclusion of my research done before 2013 being borne out strongly by the data since. Below is a graph from recent research by Bank of America (February 2021). It shows the rolling 10-year correlation of real S&P 500 earnings growth with real U.S. and global GDP growth (1989 – date). The graph clearly shows that S&P 500 earnings are consistently more correlated to global growth than to U.S. growth since ~2014.
