The IMF recently announced that China has surpassed the US as the world’s largest economy. And just as China’s economic output has picked up steam, so too has the growth of China’s equity markets.
But although Chinese equity markets have grown significantly in recent years, on a relative basis they are still dwarfed considerably by US equity markets. This relationship is evident in the market cap weighted FTSE All-World Index that excludes the mainland listed China A-shares. China only comprised 2.1% of the index as of month end November, relative to a 50.9% weighting for the US. Even with China A-shares included as demonstrated by the FTSE All-World non-R/QFII Index, China’s weight comprises only 3.9%.
Such a comparison demonstrates how market cap weighted index country weights may not be representative of relative economic strength. A dramatic example of this divergence can be observed in Japanese equity markets in 1989, when Japan’s share of world economic output was 10% yet the country comprised over 40% of the FTSE All-World Index. This disparity was a result of Japan’s equity market value outpacing its economic output.
It appears the reverse is true with respect to current Chinese markets. While Japan’s economic output did not correspond with its equity market growth, China’s GDP growth is not fully reflected in its equity market. As a result, what is now the world’s largest economy represents just a small share of the global equity landscape, as measured by market capitalization.
A GDP weighted structure like that of the FTSE GDP Weighted Index Series is designed to break this link between country weightings and market size. Instead of weighting by market cap, these indices set country weightings in proportion to GDP. As such, GDP weighted indices can correct for lack of correlation that may exist between economic and equity market growth.
This objective is perhaps best illustrated by comparing China and US weights in the FTSE All-World GDP Weighted Index over the past decade. As China has risen to become the world’s top economic power, its weighting in the FTSE All-World Index has risen in lockstep. Further, as China has overtaken the US as the world’s largest economy, the gap between their index weightings has narrowed.
Source: FTSE data, March 2004 – September 2014.
As of November month end, China’s weight in the FTSE All-World GDP Weighted Index reached 21.3%, only lagging the US weight by 0.7%. This is in stark contrast to China’s 2.1% weight in the market cap weighted FTSE All-World Index. Such examples where country weight differences are so pronounced highlight how varying approaches to index construction can result in markedly different outcomes.
© 2015 London Stock Exchange Group companies.
London Stock Exchange Group companies includes FTSE International Limited (“FTSE”), Frank Russell Company (“Russell”), MTS Next Limited (“MTS”), and FTSE TMX Global Debt Capital Markets Inc (“FTSE TMX”). All rights reserved.
“FTSE®”, “Russell®”, “MTS®”, “FTSE TMX®” and “FTSE Russell” and other service marks and trademarks related to the FTSE or Russell indexes are trademarks of the London Stock Exchange Group companies and are used by FTSE, MTS, FTSE TMX and Russell under license.
All information is provided for information purposes only. Every effort is made to ensure that all information given in this publication is accurate, but no responsibility or liability can be accepted by the London Stock Exchange Group companies nor its licensors for any errors or for any loss from use of this publication.
Neither the London Stock Exchange Group companies nor any of their licensors make any claim, prediction, warranty or representation whatsoever, expressly or impliedly, either as to the results to be obtained from the use of the FTSE Russell Indexes or the fitness or suitability of the FTSE Russell Indexes for any particular purpose to which they might be put.
The London Stock Exchange Group companies do not provide investment advice and nothing in this communication should be taken as constituting financial or investment advice. The London Stock Exchange Group companies make no representation regarding the advisability of investing in any asset. A decision to invest in any such asset should not be made in reliance on any information herein. Indexes cannot be invested in directly. Inclusion of an asset in an index is not a recommendation to buy, sell or hold that asset. The general information contained in this publication should not be acted upon without obtaining specific legal, tax, and investment advice from a licensed professional.
No part of this information may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without prior written permission of the London Stock Exchange Group companies. Distribution of the London Stock Exchange Group companies’ index values and the use of their indexes to create financial products require a license with FTSE, FTSE TMX, MTS and/or Russell and/or its licensors.
Past performance is no guarantee of future results. Charts and graphs are provided for illustrative purposes only. Index returns shown may not represent the results of the actual trading of investable assets. Certain returns shown may reflect back-tested performance. All performance presented prior to the index inception date is back-tested performance. Back-tested performance is not actual performance, but is hypothetical. The back-test calculations are based on the same methodology that was in effect when the index was officially launched. However, back-tested data may reflect the application of the index methodology with the benefit of hindsight, and the historic calculations of an index may change from month to month based on revisions to the underlying economic data used in the calculation of the index.