It is a question that generates heated debate amongst analysts, with each side fielding strong arguments for and against. While I wouldn’t dare to answer the conundrum for the global markets, it will take a stab at it here for the Russian market.
The answer in Russia is that the MICEX Index* does indeed lead GDP. The trivial proof is to simply look at the chart of the index evolution versus GDP. This is, of course, bad economics, because simple correlations do not necessarily imply causation in any meaningful sense. Nevertheless, there is a simple correlation.
Granger test
A more rigorous statistical approach that can determine if one variable meaningfully predicts the other (the Granger causality test) starts with how much of the current values of GDP can be explained by past values of MICEX. The next step is to see if adding lagged values of MICEX can improve the prediction of GDP.
If they do, then you can say the two variables are definitely linked. Doing this analysis to the Russian data reveals that the MICEX Granger-causes GDP, and that GDP does not Granger-cause MICEX.
So, should investors be worried if this relationship holds true? The MICEX Index bombed in the third quarter of this year, falling about 18% to 1366.5. Using the relationship between MICEX and GDP, this implies growth will fall to 3% in 2012 – below the consensus forecast of 4% and the Ministry of Economic Development and Trade forecast of 3.7% issued in September, but more than our baseline forecast of 2.3% growth for next year.
However, there are at least three scenarios of how the stock market will develop towards the end of the year (see chart). Clearly, the performance of the Russian stock market is being driven more by fears of a crash in Western Europe than the underlying health of the country’s companies, so the prognosis is uncertain and the outcome largely out of Russia’s hands.
If we assume that we also know third-quarter GDP data (pencil in 4.5% year-on-year growth) and assign three different Q4 levels for MICEX of 1,100, 1,500 and 1,700, the outcomes of GDP in 2012 will be the following:
- in the worst case scenario, MICEX will drop to 1,100 and that would crush growth down to a mere 1.1% in 2012;
- in the middle case, the fears subside, Europe muddles through the sovereign debt crisis and MICEX ends the year at 1,500, corresponding to 2012 GDP growth of 3.6%;
- in the best-case scenario, the EU sorts out its debt woes in an elegant and convincing way, and economies start on a robust recovery path, translates into a 1,700 level for MICEX and 4.6% GDP growth for next year.
That would be nice, but a word of caution. It is important to note that the statement, “MICEX Granger causes GDP” does not imply GDP is the effect, or the result, of MICEX movements. Granger causality measures precedence and information content, but does not by itself indicate causality in the more common use of the term.
And probably more tellingly, the performance of the MICEX index has a vanishing small Granger causality on the French and German politicians that need to face up to the crisis and act with conviction to restore confidence in the international capital markets.
* The MICEX Index is Russia’s benchmark stock index made up of the 30 largest and most liquid stocks listed on the Moscow Interbank Currency Exchange. Following the $5bn merger with its rival RTS announced in June, MICEX will be the largest stock exchange in Central and Eastern Europe.
