If someone says “stock market” most people think “USA”. That country has a share of world stock market value much larger than its already large share of the global economy. It probably has an even greater share of investment analysis and commentary dedicated to it. But US market performance has seriously lagged some really surprising countries over the long run. This is an important reminder that the most obvious investment choices are not necessarily the best ones.
Trading of company stock started in Amsterdam, the Netherlands, in 1602 with shares of the Dutch East India Company. (Debt trading had been going on in Europe for hundreds of years before that.)
At the time the Netherlands was an economic powerhouse, with an extensive international empire. It’s often forgotten the important role that it played in financial history. But nowadays the baton of leadership in financial innovation and market activity is carried by the USA.
The USA has the deepest and most liquid financial markets in the world. Its stock market is valued at around 45% of total global market capitalisation. Market capitalisation, or “market cap” for short, is the value of all shares of companies that are traded on stock exchanges at current market prices.
To put that into perspective, the next largest country stock market is the United Kingdom, at 8% of global market cap, followed by Japan (7%) and France (4%). In other words, for now and the foreseeable future, any serious investor in stocks needs to know about the USA and its markets.
The US stock market also punches above its weight relative to the size of the economy. Using World Bank figures and at current foreign currency exchange rates, which are relevant for this comparison, the USA was 22% of the world economy in 2013.
This means its share of stock market capitalisation is roughly twice its share of GDP (gross domestic product). By comparison, China is 12% of the world economy but its stock market is only 2% of the global market cap.
…just because something is big doesn’t necessarily make it a good investment. Right now I’d certainly encourage caution when it comes to US stocks.
But just because something is big doesn’t necessarily make it a good investment. Right now I’d certainly encourage caution when it comes to US stocks. According to the Financial Times the US stock market currently has a P/E (price-to-earnings ratio) of 19.6. The higher the P/E ratio the higher future earnings growth will have to be to produce a satisfactory return for investors.
The Chinese market has a P/E of 7 and Russia has a P/E of 5.5, setting the bar much lower and increasing the chances of attractive long term profits for investors. We can never predict the future. But we can significantly improve our chances of profit by paying less to invest at the time of purchase.
Even if the future is unpredictable, we can still learn a lot by studying the past. I’ve written before that the markets of Russia, South Africa and Argentina have all outperformed the US market going back as far as 1998.
This is a huge surprise to many people. In fact most of the people I know would probably write off all those places as “too risky”. In fact it’s often the developed countries that are higher risk these days, as explained in our free special report “Wealth Workout: five essential steps to investment success”.
Individually these three countries have outperformed even more since the start of MSCI index data in each case. MSCI indices have the advantage of all being calculated in US dollars, which means they’re easily comparable. (On the other hand local indices are in local currencies. So a local currency index can show a big gain, but if the currency has collapsed then the dollar gain can be minimal, or even switch over to a loss.)
The MSCI Russia index is up nine times since 1995, when it was launched, versus four times for the MSCI USA. MSCI South Africa is up seven times since 1992, its launch date, against five times for MSCI USA. And, perhaps the biggest surprise of all given the country’s regular financial crises, MSCI Argentina is up 23 times since 1987 against eight times for MSCI USA.
…country indices, which are usually seen as “high risk” by commentators, have significantly outperformed the US market over the long run.
In all cases these country indices, which are usually seen as “high risk” by commentators, have significantly outperformed the US market over the long run. Not many people are aware of that.
But what about if we go back even further? Which have been the world’s best stock markets?
Fortunately there is an excellent and authoritative source of data on this. Every year Swiss investment bank Credit Suisse produces the Global Investment Returns Yearbook, in association with London Business School.
This report analyses stock markets going back to 1900, meaning the latest version has 114 years of data (1900 to 2013 inclusive). Overall 25 countries are covered. This is an impressive data set.
Part of the report contains information on individual countries’ market performances. Figures are after inflation (“real”), measured in US dollars and assuming cash dividends received are reinvested in the market each year. However they are before tax, presumably because tax rules vary widely by type of investor, by country and over time.
Which is the best stock market in the world?
I’ll now give you a (fairly) random selection of countries. You need to guess which were the best and worst performers over the full 114 years since 1900, but also over the past 50 years, since 1964. Both periods are long stretches of history, with many ups and downs, although it’s worth remembering that many markets were hit hard by the second world war.Here’s the list: Australia, Austria, France, Germany, Italy, Japan, South Africa, Sweden, United Kingdom, USA.
Got it? I found the result really surprising when I first came across it.
The highest performer for both periods was…?
Actually both the South African and Australian stock markets returned 7.4% a year since 1900 (rounded to one decimal place). This meant $1 invested in South Africa in 1900 grew to $3,372 by the end of 2013, with compounding (profits on profits). In the case of Australia is was just a tiny bit lower at $3,332.
But South Africa has significantly outperformed Australia since 1964, returning 8.2% a year against Australia’s 5.5%. Remember these figures are after adjusting for inflation. That difference of 2.7% a year results in South African shares growing by a factor of 51 times over 50 years against less than 15 times in Australia.
This is a great illustration of the power of compounding, where relatively small differences to average annual returns result in huge performance differences over long periods of time.
And the worst performer? Austria, which was hit hard by the second world war, has only grown by a factor of two (!!!) over 114 years. In second place was Italy, which grew nine times. But Italy was by far the worst performer over the past 50 years – well after the war had ended – returning just 0.6% a year against Austria’s 3% a year. That means in half a century Italian shares have gained just 34% after inflation, but before taxes.
Why have certain countries done so much better than others? This is difficult to say and would require a lot of complex analysis. The top performers, South Africa and Australia, are both big producers of commodities. But other similarities are limited.
And what about the USA? That’s also a commodity powerhouse, yet US stocks have returned just 37% as much as South African stocks over the full 114 years, with compounding (multiplied by 1,248 versus 3,372). And the US performance since 1964 has been markedly lower as well, returning 5.8% a year on average versus South Africa’s 8.2% a year.
“…investment profits can come from surprising places. It’s rare to hear about this from talking heads on TV or journalists in the mainstream media, or even from your broker.”
What conclusions can we draw from this? Well, fellow OfWealthers, I’m not suggesting you rush out and buy South African or Australian shares today. Both markets have P/E ratios of 17.5, which is far from value territory. But the lesson is that investment profits can come from surprising places. It’s rare to hear about this from talking heads on TV or journalists in the mainstream media, or even from your broker.
Whilst the US stock market is by far the largest in the world, the historical record clearly demonstrates that it hasn’t been the best for investors. On the other hand it’s far from the worst.
In short, fellow OfWealthers, it pays to keep an open mind when you’re considering your investments. We live in a time when it’s easier than ever to invest in global markets through low cost ETFs (exchange traded funds).
Shares of these funds trade on developed country stock markets such as New York, London or Hong Kong, but the underlying investments can be in companies spread across the world. So if your broker gives you access to shares trading in New York – and if they don’t then you should change broker – then it’s easy these days to pick up a fund that invests in, say, Peru in South America.
We should think globally when hunting for the best bargains and growth prospects. There’s no reason to restrict yourself to your home market, or to the largest markets alone. It’s a world of profit opportunities out there.
Stay tuned OfWealthers,