Stocks and Shares

How long until China’s stock market overtakes the USA’s?

China’s stock markets have grown in size by over five times in the past decade. I know from past personal experience that few in the finance industry expected anything so dramatic. For now the USA still has the largest individual country stock markets, by far. But how long is that likely to last? And what does it mean for investors?

It’s well known that the USA has the world’s biggest stock markets. But what’s often missed is how quickly the markets in other parts of the world are growing – in particular in Asia Pacific.

There has been especially explosive growth in China. Stock markets are perhaps one of the most potent symbols of capitalism. Yet China, a supposedly “communist” country, has embraced them.

Okay, it’s still a highly speculative market, dominated by short term gamblers instead of long term investors. And the Chinese government has an unfortunate habit of intervening in a heavy handed way, such as when last year’s bubble burst. But, on the other hand, governments and central banks in the developed world aren’t exactly averse to market interventions these days.

Using data from the World Federation of Exchanges (WFE), which is based in London, I’ve been taking a look at market capitalisation (MCap – pronounced “em cap”) of the stock markets in different regions and countries. Market capitalisation is how much a stock, or index, or in this case whole stock market, is worth at current market prices.

Total world MCap at the end of February was $61.7 trillion. This chart shows how it was split by region.

Market-Capitalisation-by-Region

A couple of things jump right out. North America is the biggest region. Asia Pacific is much larger than Europe. Latin America, the Middle East and Africa all remain small. In the case of the Middle East it’s hard to invest there, even if you wanted to. In the case of Africa, 84% of it is in South Africa.

This next chart goes into a little more detail, breaking out the major countries from the rest of their regions.

Market-Capitalisation-by-Sub-Region

You can see that the USA easily has the largest stock markets, with over 38% of the world total, or $23.7 trillion. Obviously it’s a market that all investors have to pay attention to. It’s just a pity that it’s so expensive at the moment, which means it’s difficult to find bargains there (see here). But that will change at some point in the future.

Another thing that jumps out is that second place is easily held by China, with 14.3% or $8.8 trillion – twice as big as third placed Japan. That breaks down as $6.1 trillion in the domestic, mainland markets of Shanghai and Shenzhen and a further $3.7 trillion in Hong Kong.

This is extraordinary when you remember that the Shanghai and Shenzhen markets only opened for business in 1990, whereas Hong Kong has been going since the late 19th century.

A decade ago China had just 3.7% share, or $1.6 trillion of the $43.7 trillion global total at the time. Of that, $1.2 trillion was traded in Hong Kong, and just $0.4 trillion in the mainland Chinese markets.

The mainland markets are up over 15 times in value. Overall the Chinese stock markets have multiplied by 5.5 times in a decade.

Since 2006 the Hong Kong market, which includes a lot of mainland Chinese companies or Hong Kong companies with big operations in China, has more than tripled in size. The mainland markets are up over 15 times in value. Overall the Chinese stock markets have multiplied by 5.5 times in a decade.

The massive gain of Chinese world share has been driven partly by rising prices, as companies have grown at a fast pace. But just as importantly – perhaps more importantly – it’s been driven by the huge new amounts of capital that have been raised as companies have listed on the stock exchanges for the first time.

The rapid growth of China’s market goes a long way to explaining the regional shifts over time. The following chart shows MCap split between the Americas, Asia Pacific and EMEA (Europe, Middle East and Africa).

Mcap-by-region

Look at how EMEA and Asia Pacific have switched places in just 10 years, and how the position of the Americas has been eroded too. EMEA lost 5.4% share, the Americas lost 4.1% share and Asia Pacific gained 9.5% share.

Digging further into Asia Pacific, China added 10.6% of world share. Japan lost 4%. The rest of the region gained 2.9%. In other words it hasn’t just been China’s stock markets that have expanded rapidly, but also much of the rest of emerging Asia.

Just a quick note of explanation about Europe, which has a more complex market structure than most regions. Long gone are the days of individual country stock markets. In several cases they have merged. So Euronext – with 5.2% share – includes most of the stocks from France, the Netherlands, Belgium and Portugal.

Digging in a bit further here’s a chart of the top 24 markets by size. I was going to do the top 20, but that last few were so closely grouped I added a few more. After that they drop off quite steeply.

24-Markets-Capitalisation

A decade ago China’s stock markets, including Hong Kong, ranked 5th, which was just ahead of Canada. They were only a third as big as Japan’s and less than a tenth the size of the USA’s.

Nowadays, China’s stock markets are twice as big as Japan’s and 37% of the USA’s size. This is despite the US stock market capitalisation being a third bigger today than in was in 2006, just before the last bust.

In future I don’t expect the growth of China’s stock market to be as explosive as in the past decade, when they grew at a compound rate of over 18% a year.

But I’ve run some rough numbers, and could easily see China’s stock markets overtaking the USA’s in size some time between 10 and 15 years from now.

For that to happen they’d need to grow by a little over 10% a year, which isn’t a stretch. Don’t forget that includes both growth of existing listed companies, and new listings as more companies come to market.

And US stocks would have to drift down from their elevated valuation multiples today to something in line with historic averages. Although there will be future profit growth and new capital raising too, adding to their size.

We often hear about the approaching day when China’s economy will overtake the USA’s, measured in current dollar terms. The Economist Intelligence Unit is predicting 2026 as the crossover year. But it looks like China’s stock market could also take the top slot within a decade, or just beyond.

Don’t believe me? Well let me share something with you. Between 2002 and 2005 I lived in Hong Kong, working for a huge investment bank. One of the most important parts of my job was to set up a much bigger business in mainland China. That would allow the bank to raise capital for clients in China and trade stocks there, meaning a new source of fees and commissions.

To say that most of my colleagues were unexcited by the prospect would be a massive understatement. The market was still small, and they couldn’t see past next week. But, if my team hadn’t put the pieces in place over several years, then they would have missed out of the huge growth in the Chinese stock market in the decade and more since.

China is highly likely to keep forging ahead, with an ever bigger stock market over time.

They didn’t believe me back then. They couldn’t see the potential in China that was staring them in the face. I encourage you to believe me now. China is highly likely to keep forging ahead, with an ever bigger stock market over time.

This has big implications for asset allocation. Huge pension funds, and other institutional investors that track global stock indices, will have to allocate a lot more money to China. Private investors would be wise to get involved too, at the right price. Chinese stocks look they will be “well bid” in future. At least eventually.

Bottom line: if you want to be a serious investor you need to be in stocks. And if you’re going to be in stocks you can’t ignore these monumental changes that are happening to stock markets. We all need to become more international than we’ve been used to in the past. At least for best results.

Individual European country stock markets will become less and less relevant. The USA will lose its single country dominance, but of course remain highly important for many decades to come.

It won’t be long before there’s a new leader of the pack in the highly capitalist world of stock markets. The odd thing is that so many people think the Chinese are still “communists”.

Stay tuned OfWealthers,

Rob Marstrand

robmarstrand@ofwealth.com

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Rob is the founder of OfWealth, a service that aims to explain to private investors, in simple terms, how to maximise their investment success in world markets. Before that he spent 15 years working for investment bank UBS, the world’s largest wealth manager and stock trader with headquarters in Switzerland. During that time he was based in London, Zurich and Hong Kong and worked in many countries, especially throughout Asia. After that he was Chief Investment Strategist for the Bonner & Partners Family Office for four years, a project set up by Agora founder Bill Bonner that focuses on successful inter-generational wealth transfer and long term investment. Rob has lived in Buenos Aires, Argentina for the past eight years, which is the perfect place to learn about financial crises.