The Next Surging Market

China's GDP this second quarter was 10% higher than the previous and has grown at a similar rate annually for decades now. Compare that to a 4% annual GDP average growth for the United States. Currently, the U.S. ranks first in the world in annual GDP. Japan, the UK and France are next. Guess which countries have the top 5 largest market capitalizations. The answer is the U.S., Japan, the UK, France, and Germany (1999). It seems there is a significant correlation between market capitalization and GDP. As China, India, Brazil, and Russia's GDP's continue to grow at amazing double digit rates, does this mean their markets will follow? We believe that the answer is mostly YES. The main reason why China doesn't have a large market cap already is because many of the large companies in China are state owned and are not publicly traded. However, that trend has changed as of late and it seems like every year China is growing closer and closer to a free market economy. This could be a recipe for incredible growth in China's stock market capitalization.

In the book The World is Flat by Thomas Friedman, he mentions that Mexicans have been buying statues of their patron saint for many decades and yet now, most of those statues are imported from China. That means that it costs less to make, package, and ship these statues 10,000 miles to Mexico (which is known for its cheap labor costs) than it does to produce them in Mexico. This little tidbit shows that the world is indeed changing. It is a world where countries are growing more economically dependent and unknown economies of the past will be the leaders in the future. If the owners of the companies in Mexico who formerly produced these statues were more keenly aware of economic trends overseas, they might have been able to avoid bankruptcy at the hands of the Chinese. Just like the Mexican manufacturers, we traders need to pay attention to developments overseas. Which is the best performing stock market in history? The United States stock market made up only 20% of the world's market cap 100 years ago. Now it's closer to 45%. Which stock market had the best average real returns in the 20th century? The answer is Sweden with a 7.5% real average annual return (adjusted for inflation). The United States had the 4th best returns in the 20th century behind Australia and South Africa. (according to the book Triumph of the Optimists). So, despite popular beliefs and an average allocation of 3% to international equities (FMR research study on 401(K) allocations), investors and even traders should both take advantage of ADR's. Many people have already traded popular ADR's such as BIDU and Nokia.

The Risks of International Investing

One of the main reasons investors, don't like investing overseas, is that they fear the unknown characteristics of overseas companies. 5 out of 5 of the largest household durable companies are foreign (Sony, Philips, etc). 4 out of 5 of the largest electronic equipment companies are from outside the U.S. as well (e.g. Mitsubishi). Doesn't it seem wasteful to not consider these companies just because they are from outside the United States? We think so. All of this said, traders should always consider risks. For example, foreign equities entail more political and economic risk and tend to be more volatile. For example, drug manufacturers have performed reasonably well lately, but TEVA pharmaceuticals, has been down the past 2 weeks because of fighting in its native country of Israel. It's easy to see that wars and political upheavals seem more likely to occur in developing countries such as Israel and Indian, than in the United States. Always consider risks, be disciplined, and trade well.

Price Headley is the founder and chief analyst of BigTrends.com.