🎙️ High-Growth Paradox

Stocks closed the third quarter on Monday by hitting a record high. More record highs could be in store if bulls have their way.

Many bulls contend that stocks will keep rising through year-end, largely because they tend to rise after U.S. presidential elections as investors rotate from cash into equities.

According to Goldman Sachs, data going back to 1928 show the S&P 500 tends to rally about 4% on average from Oct. 27 through year-end.

— Matthew & Shawn

Here’s today’s rundown:

Today, we'll discuss the biggest stories in markets:

• Why stocks underperform in high-growth countries

• Will money market funds lose their allure?

This, and more, in just 5 minutes to read.

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In The News

🤔 Why Stocks Underperform in High-Growth Countries

Based on first-order thinking, stocks would perform well in high-growth countries with strong GDP growth. But it’s worth reconsidering that notion. 

A new analysis out of George Mason University challenges the assumption that rapidly growing economies yield high stock market returns. The research actually revealed a counterintuitive relationship between GDP growth and market performance.

The study examined monthly returns over a decade for country-specific MSCI exchange-traded funds across 34 nations, including Western Europe, Scandinavia, Asia, and the Americas. To ensure accurate comparisons, all ETF returns were denominated in U.S. dollars, and real GDP growth rates were used to account for inflation and currency fluctuations.

The findings are striking: Countries with the highest GDP growth rates consistently demonstrated the lowest stock market returns. Specifically, the top quartile of countries in terms of GDP growth experienced a meager average annualized return of 0.10% over the past decade. 

• In contrast, the bottom quartile achieved an average annualized return of 3.42%. Among the seven fastest-growing economies, only India delivered positive stock market returns.
  

• The research also found that high-growth countries tend to come with increased market volatility. The top quartile of high-growth nations averaged an annualized volatility of 24.70%, compared to 22.60% for the bottom quartile.

Why? A few reasons might explain:

1. Market expectations: High-growth countries may fail to meet investors' lofty growth expectations, often driving disappointing stock market performance.
   

2. Government intervention: Rapid economic growth might come at the expense of the private sector, with governments taxing or expropriating corporate earnings.
   

3. Currency effects: Currency devaluation may achieve high growth, boosting exports and GDP but harming dollar-denominated returns.
   

4. Fast growth, especially if it comes from ‘growth at all costs,’ may inflate GDP figures but not increase per-share profits for listed companies. Relatedly, fast-growing countries may have less developed capital markets, where a smaller percentage of companies are listed (making the stock market less reflective of results in the broader economy), and managers may have less experience in maximizing returns for shareholders, relying heavily on, for example, excessively issuing stock that ultimately dilutes existing shareholders.

Why it matters:

The study provides evidence supporting the currency effect theory by comparing the MSCI Emerging Markets index with its currency-hedged counterpart. The comparison reveals that currency fluctuations can greatly impact returns for U.S.-based investors.

Currency risk: The research also suggests that U.S.-based investors focused on dollar-denominated returns should be more cautious when considering investments in high-growth, emerging market countries. Strategies to mitigate currency risk are key. In sum, the analysis challenges conventional wisdom and underscores the complexity of global investing, which is rarely as simple as “Because of X, Y must be true.”

The study also highlights the value of looking beyond headline economic growth figures when making investment decisions and considering market expectations, government policies, and currency dynamics. 

The authors conclude: “All in all, if you are a U.S.-based investor who cares about dollar-denominated returns, then it may be best to avoid the high-growth, emerging-market countries out there. Or if you are going to include these ETFs in your portfolio, you better figure out a way to protect yourself against the potential devaluing of emerging-market currencies.”

Read more

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💲 Will Money-Market Funds Lose Their Allure?

Do you believe cash is king? Since the Federal Reserve’s rate cut last month, investors have plowed $126 billion into money-market funds, helping assets in such funds hit a record high of $6.76 trillion. 

Unquestionably, stocks have historically outperformed money-market funds, even when investors earn a steady 5% on their cash. But now, with more rate cuts on the horizon, investors and analysts wonder whether money-market funds will keep their allure into 2025. 

Key questions: Is all that money in such funds truly dry powder ready to be deployed? Or is it simply the result of Americans moving their savings from bank accounts to higher-yielding funds?

• The yield on money-market funds is about 4.9% on average after peaking at 5.2% last December. 

Vote with your wallet: Meanwhile, stocks, bitcoin, and other assets such as gold continue to perform well. With relatively high valuations, money-market funds are more attractive. 

• “People will be more comfortable holding a small percentage of their portfolio in cash,” says a chief investment officer at Invesco. “The retail investor is definitely voting with their dollars in terms of where they want to be.”
  

• The Wall Street Journal reported that institutional money-market assets usually rise by 3.8% when the Fed trims interest rates. Assets in such funds peak about nine months after the first rate cut, according to Bank of America. That would be around June 2025. 

Zoom out: The Fed cut its benchmark federal funds rate by half a percentage point to between 4.75% and 5% at its September meeting — its first cut since 2020. Expectations remain that the Fed will cut rates by at least a quarter point in both November and December.

Why it matters:

Some analysts and portfolio managers believe money-market funds won’t lose their allure until yields fall below 3%, which was the case in the 1990s during the Alan Greenspan-led Fed rate reductions. 

Safety net: One portfolio manager says money markets remain attractive, even if stocks keep marching higher. He recently took some profits on rising valuations and poured the cash into money markets, now roughly 15% of his portfolio. After starting his career in 2008, he learned always to have a cushion. 

• “It helps to have cash because then you can focus on, what is the opportunity in front of me for this cash, as opposed to focusing on, how bad is my stuff getting killed today.”
  

• By some estimates, cash allocations were about 17% in August, well up from 13.8%  in January 2020, when cash yields were low. 

Final thoughts: Income generated from money markets jumped to over $27 billion in August, a record on an inflation-adjusted basis.

Another investment manager for wealthy clients said he’s in no hurry to leave money-market funds. “For investors with short-term cash needs, the money funds are still attractive.”

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Quick Poll

On Monday, we asked: Do you own Silver? Why or why not?

— Nearly 40% of investors currently own Silver in some form, many via ETFs. “I have owned silver and gold for a number of years after starting to accumulate it when Treasuries paid next to nothing and continuing to hold it (physical and paper) as insurance against uncontrolled inflation and geopolitical disruptions.”

— Another Silver investor said, “I own Silver, (though) not substantially enough to retire on. Interestingly enough, it is, to me, still a rollercoaster ride.”

See you next time!

That's it for today on We Study Markets!

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