A decade ago, the Taiwanese and Mexican stock markets battled each other for the honour of making up the largest share of MSCI’s widely used Emerging Market Index. Today they are not even close.
As this week’s beyondbrics chart (after the page break) shows, the three countries currently with the largest weightings are China, Brazil and South Korea. Taiwan is fourth, while Mexico has sunk to lowly eighth. What explains these dramatic shifts?
The most striking trend is the meteoric rise in China’s weighting, which roughly tripled from 6.1 per cent to 18.2 per cent. The other countries to substantially increase their shares were Brazil, from 10.2 per cent to 16.3 per cent, and South Korea, from 9.8 per cent to 13.2 per cent. While the rise of China and Brazil has taken place almost entirely in the last five years, South Korea peaked in the middle of the decade at a weighting of 17.7 per cent.
As these countries increased their share in the index, even those which remained relatively stable – such as the Taiwanese and Mexican indices – naturally saw their weightings fall.
Why did China, Brazil and South Korea perform so strongly over the period? Rapid economic growth is part – but not all – of the explanation. Stock market performance is only weakly correlated with overall economic performance, largely because a significant chunk of a country’s shares tends to be traded privately. This explains why countries such as India and South Africa, which have also grown rapidly over the last 10 years, have seen their weightings barely budge.
Another key factor has been changes to the index’s weighting methodology. Until recently, the weightings were calculated solely on the basis of 85 per cent of a country’s free float-adjusted stock market capitalisation. This changed in 2008. As Raman Subramanian, vice president of index research at MSCI, explained to beyondbrics:
In 2008 we supplemented the pure percentage calculation with a minimum market capitalisation threshold for companies in emerging markets. This had the effect of boosting the weighting of top-heavy markets with a high proportion of large companies – such as China and Brazil – and lowering the share of markets with a high proportion of relatively small companies, such as Taiwan.
Subramanian pointed to the spate of large initial public offerings by Chinese companies in recent years, such as that of Agricultural Bank of China in July this year and Industrial & Commercial Bank of China in 2006. Both were the world’s biggest ever IPOs at the time they took place.
Countries such as Brazil, meanwhile, have been boosted by a very different factor: currency appreciation. Since the index calculates market capitalisation in dollars, when a country’s currency strengthens against the greenback – as Brazil’s real has recently – its weighting increases. Due to the Chinese renminbi’s de facto dollar peg, the country’s stocks have not been affected by currency movements in recent years.
Will we see such frequent and unpredictable changes at the top in the next decade as well? That seems less likely. As China’s economy booms, its state-owned champions grow ever larger and its currency continues its slow appreciation against the dollar, it is safe to say that the country will be be rather more difficult to dislodge than Taiwan or Mexico.