It is common to say that the stock market return is underpinned by economic fundamentals. The question then is: Is it appropriate to use GDP growth to predict stock market return? To determine this, GDP growth data and Kuala Lumpur Composite Index (KLCI) annual return from 1994 – 2016 were collected for analysis.
Chart 1 is Malaysia’s GDP growth data taken from World Bank database. Chart 2 is the yearly KLCI closing data taken from Yahoo Finance.
Chart 1: Malaysia’s GDP Growth 1994 – 2016
Chart 2: KLCI yearly data 1994 – 2017
The KLCI yearly closing index was processed to obtain the annual return data, then plotted together with the GDP growth data, as illustrated in Chart 3 below.
Chart 3
The orange curve is GDP growth while the blue curve is KLCI annual return. The data shows that the KLCI is always moving ahead of GDP growth. As such, a new chart was plotted by adding a one-year lag effect to KLCI yearly return data as shown in Chart 4.
Chart 4
From Chart 4, the relationship between GDP growth and stock market return is noticeable. The stock market movement is influenced by the expectation of the economy rather than published data. Thus, a reliable GDP growth forecast may be useful to predict stock market return. Chart 5 is the regression plot between GDP growth and KLCI annual return with one-year lag effect. Although the correlation is not particularly strong, it does suggest that 5% Malaysia’s GDP growth may move the KLCI by 7%.
Chart 5
Reblog notice: This article was first published in MY MPCA blogspot (Read more here), where engineering2finance is the main author of that article.
