This is slippage comes in. For instance, picture in a rapidly growing economy where you own shares in one company Cap, and another one, Mac, enters the stock exchange, you will not benefit from the new company’s economic impact. Why? Because you will have to reallocate some of your capital to benefit from its new earnings, though doing do will not increase the value of your portfolio. The economy will be growing, yet your portfolio will not grow.
China’s the only economy I can recall that grew quickly, so that makes them a great example. Chinese equities experienced a lot of the growth in their market value, but this is because of the increase in the number of listed companies not price appreciation from existing listed companies. With the slippage effect in mind, we can understand the relatively poor stock returns in the Chinese equity despite their massive growth in their market capitalisation.
Arnott and Bernstein used the example of war-torn and non-war-torn countries from 1900 through 2000; they found that war-torn countries caught up with and surpassed the GDP of non-war-torn countries within a little more than a generation. The catch? The war-torn countries’ stock market growth trailed their economic growth by nearly twice as much as the non-war-torn countries’. Iin other words, higher slippage. They explained that war-torn countries had to go through a high rate of equity recapitalisation; new companies needed to form, and existing companies needed to raise new capital.
This is great for the economy, but this will not translate to returns for stockholders. Short- and long-term economic growth does not directly translate to stock market returns.
So next time someone tells you “invest in X company, it’s in Y country which is growing rapidly”, now you know better to carry stick to doing your due diligence.