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Projecting market capitalization

Oct 8, 2010

How often do you come across GDP growth estimates for India and China? They are strewn across research and economic publications these days. Infact, statistics of India and China featuring amongst the top 3 economies by 2050 are the most often quoted ones. However, none of that draws as much interest as the projection of their market capitalization would. Obviously because the higher GDP would have even better use if it creates more wealth for investors.

The game of projecting market capitalization is well played by the media ahead of the results season. However, rarely are economies reckoned in terms of market cap. But with foreign investors lining up in emerging markets, it would interesting to see what the market cap rankings would look like in the future.

Goldman Sachs, for example, reckons the total capitalisation of emerging markets to rise from US$ 14 trillion today to US$ 80 trillion by 2030. This means that their share will increase from 31% of the global total to 55% in the process.

Allowing for new equity issuances, this translates into an annualised return of around 9%! Compare this with the projection of just 4% for developed markets. It seems like a no-brainer.

But the question that begs itself is: Can GDP growth be the most ideal indicator of growth in market capitalization? Well, the trend over the last 3 years for the key developed and developing economies does not suggest so. Japan's market cap for instance has been hammered way below the extent of relative fall in GDP of developed economies.

Data source: CIA, Yahoo Finance

A second answer is that growth economies may behave like growth stocks. A period of strong performance can lead to overvaluation. And from there, the subsequent returns are inevitably disappointing.

Has that stage arrived for emerging markets? Well the rule of thumb for stocks is that they are overvalued when they are priced higher for the same earnings potential as their peers. But that is certainly not the case as of now for emerging markets. As compared to their developed peers, emerging markets like India and China do have a lot of steam left for growth in profits. And for as long as that is the case, the premium valuations are well earned. Hence, while we may not be able to confirm the accuracy of projections made by Goldman Sachs on the respective marketcaps; we can certainly vouch for its high probability.

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