Regional Growth & Equity Returns
Do the fastest-growing regions produce the highest equity returns?
By: Dan Rasmussen & Chris Satterthwaite
No one who’s been paying any sort of attention to the stock market has missed the dramatic outperformance over the past decade of US equities relative to international markets.
A recent study by AQR found that the biggest driver of this outperformance was real growth, with US companies growing significantly faster than international peers. The below chart shows average (not compounded) equity returns for the US, Europe, Japan, and emerging markets over the past 10 years relative to the average (not compounded) annual revenue growth for companies in each market.
Figure 1: Equity Returns and Revenue Growth
Source: Capital IQ, Verdad
It is all too easy to extrapolate the US’s strong corporate revenue growth into the future and argue that this will be a continued source of US outperformance in the future. But growth leadership changes frequently, and, looking on a more granular basis, there’s reason to doubt the connection between higher relative growth and higher relative equity returns.
The methodology used to calculate annual revenue growth is inspired by an academic paper on macro forecasting using financial statements: we aggregate the revenue of all companies in each region and create a daily updated index of year-over-year revenue growth. We can see revenue growth moving in real time in the below chart.
Figure 2: Real-Time YoY Revenue Growth by Region
Source: Capital IQ, Verdad
Our indexed revenue growth data shows that the US has won not necessarily by growing fastest every year (the US had the fastest regional growth in only 3 out of the last 10 years) but rather by having strong growth throughout the decade, with about 20% lower volatility than Europe or Japan.
But what’s perhaps most interesting is that regressing relative equity returns against relative revenue growth had no statistical significance. The fastest-growing equity markets did not concurrently earn the highest equity returns within each year. To understand why, examine the chart below, which shows average revenue growth versus average equity returns by region by year.
Figure 3: Average Revenue Growth vs. Average Equity Returns
Source: Capital IQ, Verdad
This is a lot of numbers (and a lot of colors), but note how unrelated the left and right sides appear to be. Take, for example, emerging markets, which grew the fastest from 2016 to 2020 (mainly driven by China) yet had lagging equity returns in 2018, 2019, and 2020. Or note how slowly the US grew revenue in 2023 yet how much the stock market outperformed.
There does not appear to be a strong year-to-year relationship between growth and equity returns. That is because prices are forward looking. To successfully bet on high revenue growth, one would need to accurately project this high relative growth over the course of multiple years into the future (e.g., predicting that the US would have the highest revenue growth over the next decade, starting in 2014).
In our opinion, a simple strategy of chasing high revenue growth at the country level doesn’t produce attractive returns when rebalancing monthly or annually. We believe the simple argument to invest in the fastest-growing region doesn’t work as an investment strategy—something investors should be conscious of as they hear the seductive calls to overweight the United States even further.