In the modern day we see many of the emerging economies of the world moving forward with high growth while in contrast many of the mature western economies have anaemic growth at best. This was reinforced last week with the UK reporting preliminary quarterly growth of 0.3% (1.3% annualised) while the US fared better with an annualised 2.5%. In contrast on the 15 April 2013 we heard that China was growing at 7.7%. Does this mean we should all be selling our mature market equities and loading up on emerging markets? Or do we get enough benefit from the fact that many mature market companies are exposed to high growth markets?
To try and get an idea I ran the Google search “the best performing stock market in the world” and was rewarded with the result that in 2012 the Venezuela IBC returned around 300%. I was disappointed with this result and the majority of the other Google results for three main reasons:
- As a private investor are we really going to put a significant portion of our wealth into the Venezuela stock market? Or the Turkish XU100, Egyptian EGX, Pakistan KSE or the Kenya NSE for that matter? Well as somebody who is searching for consistent return over many years I know I’m not.
- The majority of results simply show the performance of the major stock market within each country. This is flawed because each of these markets is priced in the local currency of each country and we all know that currencies move for all manner of reasons including varying rates of currency devaluation caused by inflation. You therefore cannot compare one with the other as they have different units. It would be like saying Car A which is travelling at 110 km/hour is going faster than Car B which is travelling at 100 miles/hour. A clearly ludicrous statement.
- As the results only use the major stock market for each country they are only looking at the capital gain of each of these markets. If we truly want to understand the best performing market then we should also consider the contribution from dividends because dividends matter.
Let’s therefore answer the question from a personal long term investor perspective while considering the three points above.
Firstly to keep the analysis manageable I’m going to only compare the top 10 countries by GDP. This might be considered a little limiting but I feel it will be sufficient to answer the question as it includes 3 BRIC countries (Brazil, Russia, China) plenty of well known developed economies including the United States, Japan, Germany, France, Italy and Canada as well as a likely very important economy for many of us, the good old United Kingdom.
Now that we have our countries we next need to remove the effect of currency fluctuations. To do this we need to price all these markets in a common currency. It doesn’t matter what currency we choose as long as it is the same for all countries. Luckily there is a dataset out there which does exactly this by pricing each countries index in US Dollars. It’s called the FTSE Global Equity Index Series and is shown in the chart below.
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Unfortunately the raw data doesn’t really help us understand how each of the countries is performing relative to each other. Let’s therefore create an Index of an Index to enable us to compare apples with apples. This is shown below.
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Now we’re getting somewhere. This shows that over the past 5 years the best performing market has been the United States (and not one of the Emerging Markets) with a compound annual growth rate (CAGR) or annualised return of 3.0%. The worst performer of this group has been Italy with a CAGR of -15.7%.
This includes two of the three points above but we’re still missing the contribution that dividends make. Let’s therefore include them to create a Global Equity Total Return Index of an Index.
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While the markets of the United States are renowned for fairly derisory dividends (the S&P500 for example today only provides a dividend yield of around 2.1%) it’s not enough to knock the US off the top spot. With dividends reinvested the total return CAGR for the US is 5.2%. Second place is a very tight affair with China having a CAGR of 0.0%, Japan with 0.4%, UK with 0.7% and Canada with -0.2%. Italy remains the laggard with -12.1%.
So to answer my question it appears as though it is still sensible to have equity holdings within the traditional developed countries. I’m therefore still satisfied with my strategy with consists of nominal developed market holdings of 54% (including large allocations to the US, UK and Japan) and only 5% allocated to emerging markets. What exposure do you have to developed and emerging equity markets?
As always DYOR.