New article casting doubt on index investing

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Ferdinand2014
Posts: 2390
Joined: Mon Dec 17, 2018 5:49 pm

Re: New article casting doubt on index investing

Post by Ferdinand2014 »

Lauretta wrote: Fri Feb 09, 2024 3:48 am I just received a new article in my email inbox, highlighting the potential dangers of indexing.
https://www.bloomberg.com/opinion?cmpid ... gn=authers

One sentence struck me in particular
(Charles) Gave points out that the US stock market is now about 70% of world market capitalization, even though its economy is only 17.8% of global gross domestic product. Therefore, he says, the markets are implying that “over the next 20 years, less than 20% of the world economy will earn three times more profits than the remaining 70% or so,” or put differently, that US tech firms will be “entrenched global monopolies stretching into perpetuity.”
Perhaps one can solve this by still indexing, but by a cut and dice method using a number of indeces for different geographical regions and underweighing the US? I have been doing this since 2015 and have kept losing (relative to just having MSCI World) but the sentence above points to the fact that over the long haul it is very very unlikely that the US will outperform. Thoughts?
1.) It is 60.5 % not 70%
2.) What does 17.8% of the world GDP have to do with the '70%' US stock market. 45% of the US stock market receives it's revenue from outside the US and the US economy is not the stock market. Over 80% of the US labor force is NOT employed by the S&P 500. Implied or not, many of the companies in the S&P 500 are incredibly profitable especially the tech companies with very high margins and revenue growth.
3.) What does this have to do with index investing? Market cap is simply the collective wisdom of millions of investors. Price discovery by active investors will always be in existence to set the balance because of competition, hubris and an insatiable drive to beat the market.
“You only find out who is swimming naked when the tide goes out.“ — Warren Buffett
Dirghatamas
Posts: 576
Joined: Fri Jan 01, 2016 5:18 pm

Re: New article casting doubt on index investing

Post by Dirghatamas »

Lauretta wrote: Fri Feb 09, 2024 3:48 am
(Charles) Gave points out that the US stock market is now about 70% of world market capitalization, even though its economy is only 17.8% of global gross domestic product.
There is so much wrong with the article, where to begin.

I have been a globally market weighted passive indexer in my portfolio for > 32 years. The international part has been a huge cumulative drag over my entire investing career of three decades. Still, it seemed logical when starting investing, seems logical now and I will continue with it in retirement.

Your position is fairly rare among Bogleheads. Usually, discussions here are about overweighing US (including 100%). Rarely do we have posters who have been UNDERWEIGHING it by as much as you have. Why did you decided to under weigh? If that was logical (I wouldn't agree), why change now?

1) US is (according to Vanguard VT fund) ~61% of world market cap (not 70%). I suspect the various numbers come from free float adjusted vs. raw. Some other data shows even less (close to 50% market cap). Handling of partially state owned companies (consider Aramco) can cause big variations in world market cap calculations. Aramco has a market cap of ~2T$ but very little is "publicly investible". China has a huge stock market but different handling of A vs. H shares, state owned companies, HongKong vs. Shanghai exchanges..you can get wildly varying numbers for world stocks market cap and a country's stocks market cap, depending on how you do the math..

2) US is not alone in having a higher market cap % vs. GDP. Consider Switzerland. It makes much less than 1% of world GDP but makes 2.3% of world market cap (according to VT). Nestle is its biggest company but hardly sells any significant % of its products there. Its biggest market is USA and most of its product there show up in US GDP (not Switzerland). So, should you NOT invest in companies headquartered in Switzerland? If so why?

3) Company headquarters/ incorporated: Taking an even more extreme view, consider Delaware. It is the second smallest state in the USA. Yet > 60% of fortune 500 companies are incorporated there. These companies typically do business in all of USA and usually the world. Does anyone care about the GDP of Delaware in deciding to invest in the S&P 500? If not, why do we care where a multi national company's headquarters are?

4) US is quite rare (along with other so called Anglo-Saxon countries) in having a large % of its GDP and companies be public companies. Many advanced economies e.g. Germany have different common company structures like mid-sized privately held or family held. Other economies have large state run or partially state run companies. You can't really invest in those in any diversified, passive way.

5) US % world market cap is NOT a new phenomenon. Since the second world war, US being ~45-55% or more of world cap is the default situation. It only went down significantly below 50% for a short time in the 80s during the rise of Japan. So, the present situation isn't unique.

6) Company's headquarters vs. country's GDP is meaningless: Consider Apple. It is incorporated in Delaware and headquartered in California. Its hardware is mostly made in Asia/ China. For GDP calculations, its hardware products show up in that heading rather than USA. Even its worldwide IP is typically identified as Ireland (tax haven). It is very complex (and foolhardy) to trace all these world wide global supply chains vs. GDP vs. the headquarter country..

7) “over the next 20 years, less than 20% of the world economy will earn three times more profits than the remaining 70% or so,” This sentence you highlighted from the article makes my head explode. Clearly, the article author understands the subject and is just making this provocative statement as clickbait. Leaving aside USA stocks, why would anyone think that profits = revenue or profits = GDP. Consider Walmart, USA's largest retailer. It brings huge revenue but much smaller profits. On revenue of ~611 billion US $ for 2023, its operating income was just 20 billion $ or just 3% profit margin :shock: . Completely different situation if you look at say Apple or Google or Nvidia.
Profits =/= Revenue. Profits =/= GDP. Market cap goes by earnings/ profits not revenue.

The sane thing to do (almost always) is to just passively follow the market. I wouldn't overweigh the US but I certainly wouldn't under weigh it.
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