Mr Pearce's analysis hinges on an intriguing reading of Britain's national accounts that suggests profits are at a cyclical trough relative to the output of the economy (as defined by the 'value added' by UK non-financial corporations). Assuming there is so-called slack in the economy - that is, neither the work force nor factories are working flat out - companies should be able to meet swelling aggregate demand without incurring much higher costs, at least in the short run. The share of profits in the economy should then rise, benefiting shareholders.
But there's a problem with this theory: the link between GDP growth and the stock market is less clear than one might imagine. In fact, over the long term, there appears to be no link at all. In their seminal 2002 book, 'Triumph of the Optimists,' Elroy Dimson, Paul Marsh and Mike Staunton of the London Business School compiled and analysed 100 years of stock market data across various countries, only to find a negative correlation between returns and per-capita GDP growth. Rapid growth was associated with weak stock market returns.
The academics update their research each year in the 'Credit Suisse Global Investment Returns Yearbook,' the latest edition of which was published this month. Somewhat cheekily, it includes a chart from an (unnamed) asset manager appearing to show a correlation between growth and equity returns in the US. But it turns out the asset manager has lagged equity returns by a year. In other words, you can make money in the stock market if you can perfectly predict GDP growth the following year. Given the notorious inaccuracy of GDP forecasting, this is not a workable investment strategy.
But trying to predict stock market returns based on past GDP growth - which, as far as statistically possible, we do know - simply does not work. The academics crunched through the numbers for 85 countries since 1972 and discovered that the stock markets of countries with low historic growth actually outperformed those of countries with high historic growth.
This is partly because both bombed-out shares and underperforming economies bounce back - the recovery effect. But there's also a more enduring reason: stock markets do not necessarily reflect the economies of the countries in which they sit. This is particularly true of the London Stock Exchange, with its legacy of empire. It is often pointed out that some three-quarters of FTSE 100 earnings come from abroad. Less well flagged is that the stock market's industrial composition is radically different from that of the economy. As Mr Pearce of Capital Economics concedes, the oil and gas sector comprises nearly a fifth of the blue-chip index, but less than 2 per cent of value added in the UK economy, which is what matters for GDP calculations.
Investors might draw one of two conclusions. One is to ignore the market and pick stocks in individual companies whose earnings will benefit from Britain's recovery. The other, which requires less effort, is simply to ignore the earnings cycle and buy shares for their long-term return characteristics.
Over the 113 years since 1900, UK stocks have returned 5.3 per cent a year after inflation, overwhelmingly in the form of dividends, according to Dimson, Marsh and Staunton. That's nearly four times the return on bonds - an outperformance usually explained as the reward for taking greater risk, the so-called 'equity risk premium'. The perennial case for risk taking may be a better reason than the recovering economy to be a UK equity bull.
