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talization, the smallest of which is New Zealand with a capitalization of $19 billion in 2001.
These countries made up 79% of the World gross domestic product in 2001.
The first five columns of Table 21.1 show market capitalization over the years 1996“2001.
The first line shows capitalization for all world exchanges, showing total capitalization of cor-
porate equity in 2001 as $25.7 trillion, of which U.S. stock exchanges made up $13.2 trillion
(49%). The figures in these columns demonstrate the volatility of these markets; indeed, world
capitalization in 2001 was less than it was two years earlier and in the entire Pacific Basin it
was less than it was in 1996!
The next three columns of Table 21.1 show country equity capitalization as a percentage of
the world™s in 2001 and 1996 and the growth in capitalization over the five years 1996“2001.
The large volatility of country stock indexes resulted in significant changes in relative size. For
example, U.S. weight in the world equity portfolio increased from 37% in 1996 to 49% in 2001,
while that of Japan decreased from 24% to 11%. The weights of the five largest countries
behind the U.S. (Japan, U.K., France, Germany, and Switzerland) added up to 39.2% in 2001,
so that in the universe of these six countries alone, the weight of the U.S. was only 62%
[49/(49 39.2)]. Clearly, U.S. stocks may not comprise an adequately diversified portfolio
of equities.
Unlike the 1980s and early 1990s, the period 1996“2001 saw a decline in the value of equi-
ties of the Pacific Basin (growth of 4%), but a resurgence in North America (growth of
136%) and Europe (104%). These numbers show that economic position of countries is just as
precarious as the stock prices that capitalize the future value of the particular corporate sectors
of these economies.
The last tree columns of Table 21.1 show GDP, per capita GDP, and the equity capitaliza-
tion as a percentage of GDP for the year 2001. As we would expect, per capital GDP in de-
veloped countries is not as variable across countries as total GDP, which is determined in part
by total population. But market capitalization as a percentage of GDP is quite variable, sug-
gesting widespread differences in economic structure even across developed countries. We re-
turn to this issue in the next section.


Emerging Markets
For a passive strategy one could argue that a portfolio of equities of just the six countries with
the largest capitalization would make up 79.2% (in 2001) of the world portfolio and may be
sufficiently diversified. This argument will not hold for active portfolios that seek to tilt in-
vestments toward promising assets. Active portfolios will naturally include many stocks or
even indexes of emerging markets.
Table 21.2 makes the point. Surely, active portfolio managers must prudently scour stocks
in markets such as China, Brazil, or Korea. Table 21.2 shows data from the 20 largest emerg-
ing markets, the most notable of which is China with equity capitalization of $170 billion
(0.66% of world capitalization) in 2001, and growth of 651% over the five years 1966“2001.
But managers also would not want to have missed a market like Poland (0.09% of world capi-
talization) with a growth of 287% over the same years.
TA B L E 21.1
Market capitalization of stock exchanges in developed countries
Fifth Edition




Capitalization
Market Capitalization
Bodie’Kane’Marcus:




GDP per as % of
Essentials of Investments,




U.S. Dollars (billions) Percent of World Growth GDP Capita GDP

2001 2000 1999 1998 1997 1996 2001 1996 1996“2001 2001 2001 2001

World $25,711 $31,668 $26,198 $20,703 $17,966 $14,494 100% 100% 77% 30,960 5,450 83
North America 13,169 15,601 13,166 10,008 7,685 5,590 51.2 38.6 135.6
Management




United States 12,597 14,882 12,623 9,528 7,271 5,294 49.0 36.5 137.9 10,208 35,900 123
Canada 572 719 543 479 413 295 2.2 2.0 94.0 700 22,525 82
VI. Active Investment




Europe 7,305 9,185 7,657 6,948 4,878 3,585 28 25 104
United Kingdom 2,256 2,639 2,475 2,179 1,635 1,206 8.8 8.3 87 1,424 23,750 158
France 1,119 1,356 937 843 518 427 4.4 2.9 162 1,307 21,910 86
Germany 896 1,204 1,062 992 709 481 3.5 3.3 86 1,848 22,500 48
Switzerland 633 712 662 596 447 303 2.5 2.1 109 247 34,019 256
Netherlands 559 723 634 607 479 339 2.2 2.3 65 381 23,810 147
Italy 556 736 526 464 247 214 2.2 1.5 160 1,090 18,950 51
Spain 336 337 310 311 212 150 1.3 1.0 124 582 14,590 58
Sweden 212 375 253 247 188 139 0.8 1.0 52 210 23,580 101
21. International Investing




Finland 164 379 173 93 60 42 0.6 0.3 295 121 23,260 136
Belgium 130 158 152 173 105 82 0.5 0.6 58 230 22,420 56
Denmark 90 101 75 88 61 44 0.3 0.3 103 163 30,450 55
Ireland 76 75 58 59 36 27 0.3 0.2 185 103 27,140 73
Norway 69 54 52 56 47 35 0.3 0.2 100 165 36,600 42
Greece 55 88 83 51 27 17 0.2 0.1 224 116 11,000 47
Portugal 49 74 59 75 47 23 0.2 0.2 111 110 10,940 45
Israel 39 47 35 29 24 18 0.2 0.1 120 110 17,159 35
Austria 24 28 31 35 27 26 0.1 02 8 189 23,078 13
New Zealand 19 23 26 26 36 29 0.1 0.2 34 49 12,763 39
Pacific Basin 4,642 6,184 4,764 3,201 4,729 4,830 18 33 4
Japan 2,947 4,246 3,092 2,188 3,138 3,509 11 24 16 4,148 32,720 71
Hong Kong 532 553 404 254 452 289 2.1 2.0 84 162 10,940 329
Companies, 2003




Australia 363 384 378 249 276 219 1.4 1.5 65 357 18,459 102
© The McGraw’Hill




Taiwan 205 331 260 173 232 152 0.8 1.0 35 282 12,620 73
Singapore 113 143 133 72 116 138 0.4 0.9 18 86 20,880 132

Source: Datastream, July 2002.




723
724
TA B L E 21.2
Market capitalization of stock exchanges in emerging markets

Capitalization
Market Capitalization
GDP per as % of
Fifth Edition




U.S. Dollars (billions) Percent of World Growth GDP Capita GDP

2001 2000 1999 1998 1997 1996 2001 1996 1996“2001 2001 2001 2001
Bodie’Kane’Marcus:




China $170 $ 94 $ 78 $ 67 $ 48 $ 23 0.66% 0.16% 651% 1,180 928 14%
Essentials of Investments,




Brazil 169 220 155 135 175 86 0.66 0.59 97 503 2,810 34
Korea 151 218 181 35 95 104 0.59 0.72 45 423 8,870 36
Mexico 140 128 115 96 97 74 0.55 0.51 89 621 6,190 23
South Africa 101 123 126 121 148 124 0.39 0.86 19 112 2,520 90
Management




India 88 139 93 72 113 88 0.34 0.61 1 485 470 18
Malaysia 76 98 90 50 170 167 0.30 1.15 54 89 3,720 86
VI. Active Investment




Russia 66 49 35 44 93 37 0.26 0.25 80 310 2,144 21
Chile 53 49 47 45 61 48 0.20 0.33 10 64 4,170 82
Turkey 36 75 39 54 36 24 0.14 0.16 50 148 2,230 24
Argentina 29 37 51 48 56 43 0.11 0.30 31 267 7,120 11
Thailand 26 30 46 17 46 89 0.10 0.61 71 115 1,820 23
Poland 22 29 25 14 7 6 0.09 0.04 287 176 4,566 13
Philippines 20 23 41 26 55 62 0.08 0.42 68 71 862 28
Indonesia 19 32 39 12 76 60 0.07 0.41 68 145 688 13
Czech Republic 10 13 12 13 11 13 0.04 0.09 26 52 5,137 19
Hungary 9 14 14 15 8 4 0.04 0.03 128 56 5,482 16
21. International Investing




Peru 6 8 7 8 11 10 0.02 0.07 36 54 2,070 11
Colombia 6 5 7 10 22 17 0.02 0.12 65 83 1,940 7
Venezuela 4 4 4 4 10 4 0.02 0.03 2 130 5,280 3

Source: Datastream, July 2002.
Companies, 2003
© The McGraw’Hill
Bodie’Kane’Marcus: VI. Active Investment 21. International Investing © The McGraw’Hill
Essentials of Investments, Management Companies, 2003
Fifth Edition




725
21 International Investing


These 20 emerging markets make up 16% of the world GDP and, together with the 25 de-
veloped markets in Table 21.1, make up 95% of the world GDP. Per capita GDP in these coun-
tries in 2001 was quite variable, ranging from $470 (India) to $8,870 (Korea); still, no active
manager would want to ignore India in an international portfolio. Market capitalization as a
percent of GDP, which ranges from 3% (Venezuela) to 90% (South Africa), suggests that these
markets are expected to show significant growth over the coming years, even absent spectac-
ular growth in GDP.
The growth of capitalization in emerging markets over 1966“2001 was much more volatile
than growth in developed countries (as disastrous as 71% for Thailand), suggesting that both
risk and rewards in this segment of the globe may be substantial.

Market Capitalization and GDP
The contemporary view of economic development (rigorously stated in deSoto 2000) holds
that a major requirement for economic advancement is a developed code of business laws, in-
stitutions, and regulation that allows citizens to legally own, capitalize, and trade capital as-
sets. As a corollary, we expect that development of equity markets will serve as catalysts for
enrichment of the population, that is, that countries with larger relative capitalization of equi-
ties will tend to be richer.
Figure 21.1 is a simple (perhaps simplistic since other relevant explanatory variables are
omitted) rendition of the argument that a developed market for corporate equity contributes
to the enrichment of the population. The R-square of the regression line shown in Figure
21.1 is 35% and the regression coefficient is .73, suggesting that an increase of 1% in the
ratio of market capitalization to GDP is associated with an increase in per capita GDP of
0.73%. It is remarkable that not one of the 25 developed countries is below the regression
line; only low-income emerging markets lie below the line. Countries like Venezuela and
Norway that lie above the line, that is, exhibit higher per capita GDP than predicted by the
regression, enjoy oil wealth that contributes to population income. Countries below the line,
such as Indonesia, South Africa, Philippines, and India, suffered from deterioration of
the business environment due to political strife and/or government policies that restricted



F I G U R E 21.1
100000
Per capita GDP tends
Norway U.S.
to be higher when
Austria market capitalization
as a percentage of
Per capita GDP ($)




10000 Argentina GDP is higher.
Venezuela
(log scale)

South Africa
China
1000
Philippines
Indonesia
India

Developed countries Emerging markets Regression line
100
1 10 100 1,000
Market capitalization as a percentage of GDP
Bodie’Kane’Marcus: VI. Active Investment 21. International Investing © The McGraw’Hill
Essentials of Investments, Management Companies, 2003
Fifth Edition




726 Part SIX Active Investment Management

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