One of the justifications for emerging markets doing better than developed markets is that the former now account for a much larger proportion of the global economy than they used to do and markets must reflect this fact. Put another way, the argument is that the share of emerging markets in market capitalization must reflect their rising share in the global gross domestic product (GDP).
The underlying assumption is that the market cap of emerging markets, as a proportion of global market cap, is much lower than their share of world GDP, and hence, market cap in these countries must expand. But is this really true?
Let’s take India’s share of global market capitalization first. The Bespoke Investment Group put out a list of countries and their percentage of world market capitalization on 15 December. According to it, the share of the US in world market cap is 29.61%, that of India 2.79% and of China 7.27%.
According to data from Bloomberg, India’s market cap as a percentage of world market cap was 2.8% on 31 December, China’s was 7.2% and that of the US was 29.9%. Data from the World Federation of Exchanges show that the Bombay Stock Exchange accounted for 2.7% of world market cap at the end of November, while the Chinese bourses had 7.6%.
Clearly, there are differences in the percentages put out by different sources, but if we take a range, then India accounts for 2.7-2.8% of world market cap.
The next step is to compare that with India’s share of global GDP. Taking estimates by the International Monetary Fund (IMF), we find that India’s share of global GDP in 2009 (in current dollars) is expected to be 2.2%, China’s 8.3% and that of the US, 25.7%. It indicates that India’s market capitalization as a proportion of global market cap is already higher than its share of global GDP. It’s a clear sign that the Indian market is overvalued.
But markets are supposed to be forward-looking and perhaps the GDP numbers we should use are those for 2010 rather than for 2009? Trouble is, if we use the 2010 GDP projections put out by IMF, India’s share of 2010 GDP continues to be 2.2%. Of course, it is probable that IMF is underestimating India’s GDP growth.
But even if we take that into account and even if we assume a big jump in India’s growth that takes its GDP to 2.8% of global GDP in 2010, it would still mean that India’s share of market cap is equal to its share of GDP. To be sure, India’s higher GDP growth relative to most countries means that our share of global GDP will increase every year. Nevertheless, at the moment it does look as if the Indian markets have already discounted this growth well into the future.
China’s share of global GDP, according to IMF projections, is 8.3% in 2009 and 8.7% in 2010. That is more than China’s share of GDP, according to all the three sources cited above. As for the US, its share of global GDP is projected at 25.7% for 2009 and 24.3% for 2010. That’s lower than its share of world market cap. In other words, the Chinese markets still have some way to go to catch up with their share of the economic pie, but the Indian market already fully reflects the improvement in the country’s economy.
It’s worth going back and checking these numbers for 2004, at the start of the last boom. Data from Bespoke Investment show that in January 2004, India’s share of world market capitalization was 0.9%. The IMF numbers show that, in 2004, India’s share of global GDP was 1.6%, almost double its share of market cap.
Similarly, while China’s share of global market cap was 1.7% in January 2004, its share of world GDP was 4.6%. In other words, the rationale for a big gain in Indian and Chinese stocks existed at the time. The subsequent rally in the stock markets in both India and China bridged the gap between the market cap and GDP shares, especially for India.
In contrast, the US share of world market cap in January 2004 was 43.7%, while its share of global GDP was 28.3%. No wonder than that its stock markets underperformed those of China and India.
In short, for the Indian market, the rally of 2003-07 was a one-off event that served to bring market cap more in alignment with the country’s economic strength. With India’s share of market cap already higher than its share of global GDP, future increases in market cap will have to depend on a breakthrough in economic growth.
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