GLOBAL INVESTING AND THE RISE OF CHINA, INDIA, AND

GLOBAL INVESTING AND THE RISE OF CHINA, INDIA, AND EMERGING MARKETS FINA 425 Prof. Dr. Korhan GOKMENOGLU BY: SIAMAND HESAMI MARAL MEREDOVA ELNUR SAMADLI

OVERVIEW:  THE WORLD’S POPULATION, PRODUCTION, AND EQUITY CAPITAL  CYCLES IN FOREIGN MARKETS  DIVERSIFICATION IN WORLD MARKETS  THE WORLD IN 2050

Introduction:  Until the late 1980s foreign markets were almost exclusively the domains of native investors and were considered too remote or risky to be entertained by outsiders.  At the end of World War II, U.S. stocks was almost 90 percent of the world’s equity capitalization;  But today, the U.S. market constitutes considerably less than half of the world’s stock value, and that fraction is shrinking.

Introduction:  To invest only in the United States is to ignore the majority of the world’s equity capital.

The 2005 World Population

The 2006 World GDP

The 2007 World Equity

The emerging nations’ share of output and equity capital has been rising rapidly and will continue to do so.

CYCLES IN FOREIGN MARKETS In the past, strong U.S. markets were often coupled with weak foreign markets and vice versa. In the 1970s and 1980s, U.S. stock returns lagged behind both Europe and Japan, then surged to the head of the pack in the 1990s, only to lag behind again this decade.

These differences in returns emphasize the importance of maintaining a well-diversified world portfolio.

The Japanese Market Bubble In the 1970s and 1980s, Japanese stock returns averaged more than 10 percentage points per year above U.S. returns. In 1989, for the first time since the early 1900s, the market value of the American stock market was no longer the world’s largest. The Nikkei Dow Jones, which had surpassed 39,000 in December 1989, fell below 8,000 in The mystique of the Japanese market was broken.

The Emerging Market Bubble The collapse of the Japanese market shifted the emphasis of global enthusiasts to emerging markets: India, Indonesia, and even China, Latin America, Argentina, Brazil, and Mexico. The year 1997 marked the beginning of the collapse. In that two-year period, virtually no emerging market was safe. Most of the stock markets fell by at least 50% in dollar terms.

The New Millennium and the Technology Bubble The last three years of the twentieth century, marked by the emergence of a huge technology bubble. A few months into the new millennium, the technology bubble burst and stocks fell into a severe bear market. All of the developed countries’ markets fell by at least 50 percent: from March 2000 through October 2002.

What have these market cycles taught us about international stocks?  No single market is always dominant,  The globalization of the world markets affords investors more opportunities for spreading their risk than are available in the domestic markets.

DIVERSIFICATION IN WORLD MARKETS  The principal motivation for investing in foreign stocks is not that foreign countries are growing faster and therefore will provide investors with better returns. Foreign investing provides diversification. International diversification reduces risk. This asynchronous movement of returns dampens the volatility of the portfolio.

The correlation of returns between stocks or portfolios of stocks is measured by the correlation coefficient. An asset with a low correlation with the rest of the market provides better diversification than an asset with a high correlation.

“Efficient” Portfolios: Formal Analysis How do you determine how much should be invested at home and abroad? by analyzing the historical return data by mathematical techniques of formal portfolio analysis

Risk-return trade-off ( Efficient Frontier)

Sector Diversification Returns between international industrial sectors are not becoming more correlated One reason for the decreased correlation between sectors is the moderation of the business cycle, which means that shifts in sector demands, rather than changes in the overall economy, become the primary sources of changes in firm profitability. (International Incorporations)

Sector Allocation around the World

The financial sector is the largest sector in every region of the world The largest share of the financial market value sector is found in Europe, belonging to companies such as HSBC, UBS, and the Royal Bank of Scotland. The partial privatization of the Bank of China, the Industrial and Commercial Bank, and the China Construction Bank have also made this sector the largest in the emerging markets. In the United States, the largest financial firms are Citigroup, Bank of America, and AIG.

Top 20 U.S. and Foreign Companies by Total Market Value in June 2007

Private and Public Capital Exxon Mobil may be the largest company by market value in the world and it has the largest reserves of oil and gas (20 billion barrels). Saudi Arabia’s Aramco and Iran’s NIOC have reserves of about 300 billion barrels! In many countries, gas, electric, and water facilities are still owned and operated by government Growth of the world’s capital stock will come not only from private entrepreneurs but from the privatization of many government-owned assets.

The 2050 World Population

The 2050 World GDP

The 2050 World Equity

List of countries by future GDP estimate

Conclusion:  Sticking only to U.S. equities is a risky strategy for investors.  Sticking only to U.S. equities would be just such a bet since U.S.-based equity will likely shrink to less than 18 percent of the world market by midcentury.  Equity in China and India will grow to more than one-third of the world’s equity market and be twice the size of the United States.  Only those investors who have a fully diversified world portfolio will be able to reap the best returns with the lowest risk.

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