January 17, 2007
TOURING THE GLOBE BY EQUITY MARKET CAP
Asset allocation, we're told, is the critical variable driving success and failure for diversified portfolios in the long haul. If you get asset allocation wrong, market timing and security selection can't save you. We're inclined to agree, although that generally sound counsel suffers from subjectivity once you go into the details of designing actual portfolios. One man's notion of an asset allocation dream is another's nightmare. Perhaps that's inevitable, as every asset allocation should be custom designed for each investor's goals, risk tolerance, time horizon, and so on.
Standard benchmarks, in short, are hard to come by for asset allocation. But if there's such a thing as a default, Mr. Market's take on how to allocate money arguably comes closest to such an ideal. By "Mr. Market" we're referring to the distribution of market capitalization. To be sure, market cap is under attack these days from new-fangled concepts of benchmark crafting, i.e., fundamental indexing. But say what you might about market cap, it still seems to be the most objective measure of the capital markets. You may or may not want to own equities based on market-cap allocations, but the measure remains a valuable and largely objective standard by which to gauge trends in the financial markets.
With that in mind, we crunched the numbers on the world equity markets, courtesy of data from S&P/Citigroup Global Equity Indices. Although this benchmark series offers dozens of indices, we looked at seven with the idea of forging a big-picture overview of the changing face of market-cap equity allocations on a global scale.
Theoretically, market-cap-based allocations are optimal for the average global investor with an infinite time horizon, meaning that such allocations are suitable for everybody in the aggregate and nobody in particular. So while the following shouldn't be considered informed counsel on how to divvy up a portfolio, it does offer some context for thinking about designing a global equity portfolio and how Mr. Market's voted in recent history.
Let's start with the U.S. As you can see from the table below, the good 'ole U.S. of A.'s market capitalization represented 43.9% of the global equity capitalization on January 1, 2007. (This and all figures that follow are dollar-based numbers, meaning that allocations would look different if we chopped up the markets based on euros, yen or other currencies.) A market-cap-inspired view of the world implies that U.S. stocks should comprise 43.9% of a global equity portfolio. That's down from 47.2% at the start of 2006 and 53.4% at the beginning of 2000. On the other hand, the U.S. share of world equity markets in 2007 is up from 1995's 40.7%.
The world's second-biggest economy has fared worse. As this year opened, Japan's market-cap weight of global equities was 10%, down from 11.5% the year before and from 23.1% in 1995.
Europe's slice of the equity pie, on the other hand, is rising. At the start of 2007, Europe's weight was 30%, up from 27.1% a year ago and from 25.1% in 1995.
Ditto for Asia Pacific ex-Japan. The region's market cap share outside of Japan climbed to 5.3% this year from 4.8% in 2006 and from just 2.3% in 2000. This year's tally is also up from 1995's 4.6%.
In fact, emerging markets overall are taking a bigger share of the global economy's market cap, although not as much as one might think. At this year's start, emerging markets claimed 7.5% of the planet's equity market capitalization, up from 5.9% the year before and from 3.8% in 2000.
Latin America's collective market cap rose slightly in the past year to 1.6% of global equity capitalization from 1.3% in 2006. Longer term, however, Latin America's stock markets are a shrinking presence, falling from a 1.9% share back in 1995.
Finally, it's instructive to look at global equity markets less the U.S. presence. By that measure, there's growth to recognize, with global ex-U.S. posting a 56.1% share at this year's open, up from 52.8% in 2006 and from 46.6% in 2000. Relative to 1995, however, foreign markets' share of global equity cap has fallen slightly.
All of which provides some perspective on how to indulge in active money management. If there's any hope of beating the global equity markets, one has to build portfolios that differ from Mr. Market's allocation. Now that you know how Mr. Market's bets are placed, the question is whether you're inclined to take an alternative view. Many have tried and failed, but hope springs eternal, even on a global scale.
Posted by jp at January 17, 2007 9:57 AM
well written - like you say, it's the most rational place to start at a purely passive level, but then introduce more and more active elements to the portfolio whenever the mood strikes. Since we're all gambling on things, at least you can choose when to play and how much on every hand. Not in and out of the market - just passive and active, but always invested to a "default" degree.
Posted by: scott at December 22, 2007 2:39 AM