Which Country's Stock Market Is the Most Expensive?

by: The Ox

Is the UK stock market three times more expensive than the German stock market – it is by at least this measure!

In a recent article, Bespoke Investment Group published the stock market capitalizations of the world’s major economies. I decided it would be interesting to take a look at the ratio of these countries Market Capitalizations to their GDPs.

By simply dividing each country’s stock market capitalization by its GDP, I was able to generate the bubble graph below. The size of the bubble indicates the size of the market cap but the key here is the Market Cap to GDP ratio as measured by the y axis.

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There are several reasons determining the size of a country’s stock market capitalization including, for example, the equity-buying culture of the local population, company use of debt versus equity financing, the country’s regulatory and legal environment as well as how easy it is to list on the local exchange. In general however, it is probably safe to assume that there should be a positive correlation between a country’s market capitalization and its GDP. Indeed it turns out there is a very high, 0.96 correlation between the world’s largest economies GDPs and their stock market capitalizations.

What is more interesting, however, is that the analysis puts paid to my own preconception that Emerging Markets are likely to have stock market capitalizations that greatly lag their fast-growing GDPs in size, at least as compared to Developed Markets. As things stand today however, Emerging Markets turned out to have an average ratio of Market Cap to GDP of 0.93, not much less than the comparable Developed Markets ratio of 1.09. This may indicate that Emerging Markets are adequately capitalized and investors may not make a killing by investing there at the present time.

Most shocking to me was the extent to which this ratio diverged between countries. For example, the country with the lowest ratio in the sample (Italy) was nine times lower that the highest ratio in the sample (Singapore). Germany had a ratio five times lower than it neighbor Switzerland. This wide divergence was apparent for both Emerging and Developed countries.

I was also interested to see whether a low Market cap to GDP ratio might be an indicator that a country’s stocks are undervalued. Intuitively, if the markets were to suddenly award a higher price multiple on a country’s stocks, then that country’s market cap to GDP ratio would rise accordingly, albeit not in direct proportion (market cap being composed of both a company’s equity and debt). It turns out that there is somewhat of a correlation between a country’s market cap to GDP ratio and traditional value multiples, with the respective correlations being 0.46 for price to cash flow, 0.45 for price to sales, 0.27 for price to book and 0.18 for price to earnings.

As to whether Italian stocks are really nine times cheaper than Singaporean stocks, the markets will ultimately make that determination. Nevertheless, the analysis does underpin to an extent my recent suggestion that Italian stocks are amongst the cheapest in the world.

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Source of GDP: International Monetary Fund 2010

Designation as an “Emerging Market” by Dow Jones 2010

Value multiples derived from various country ETFs as listed by Morningstar.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.