Geographic Regions in the GFD Indices, Part 1
Bryan Taylor, Chief Economist, Global Financial Data
One of the goals of investing is to find assets which are not correlated with one another in order to diversify your investment portfolio and reduce risk. You can diversify by asset type, by market cap, by sector or by geographic location. Each index service chooses different geographic groups to track.
The goal is to create regional indices that do not correlate with other regional indices. While other index companies, such as MSCI, FTSE Russell or S&P Dow Jones focus on current countries and the countries that make up those indices, GFD takes a long-term perspective to understand the interrelationships between countries over a period of two centuries, not two decades. Cultural factors that affect the behavior of different countries are considered in grouping the countries together. GFD has divided its indices into ten geographic sectors that maximize the diversification of its groups.
MSCI places a country into one of four categories: developed, emerging, frontier and standalone. S&P Dow Jones has three categories: developed, emerging and frontier. FTSE Russell divides countries into four categories: developed, advanced emerging, secondary emerging and frontier. Countries are placed in each category according to the level of economic development, the size and liquidity requirements of individual securities, and market accessibility (which includes openness to foreign ownership, ease of capital inflows and outflows, efficiency of the operational framework, availability of investment instruments and stability of the institutional framework). The equal treatment of investors, the free flow of capital and the cost of investment are key factors in determining which category a country falls into.
Currently, index creators differentiate between developed and emerging markets because there is a low correlation between the performance of the two groups. Developed countries have a long history of activity on stock exchanges and a high level of per capita GDP. Emerging markets have shorter histories of stock exchange activity and a lower per capita GDP. It should be recognized that “emerging markets” are a recent creation that resulted from the global growth of markets in the 1980s.
Before World War II, many larger companies in “emerging markets” listed their shares in London, Paris, Berlin or New York. More capital and liquidity was available on the major exchanges than in local markets. Small companies with limited needs for capital would list on the local stock exchange while larger companies listed in London or Paris. Local exchanges often dealt more in debt than in equity. Before World War II, there were developed markets and colonial markets, there were European markets and American markets, but it was primarily because of the decolonization after World War II and the desire to take advantage of the growth opportunities in “emerging” markets that this differentiation occurred.
By creating different geographic groups, the implication is that these regions have similar histories and their financial markets will behavior similarly. For example, neither Canada nor the United States was attacked during World War II and both have a British heritage, so putting them together in a geographic group and differentiating them from Latin American countries makes sense. Countries occupied by the Japanese before World War II (Taiwan and Korea) have both emerged from one-party rule and become vibrant democracies that successfully export goods to the rest of the world. Each group of countries must share common histories.
We have divided the world into ten groups, six of which include developed countries and four of which include emerging markets, that have some common themes with each other in terms of geography, history and similarities in their development over time. These ten geographic regions are British Asia, Japanese Asia, Emerging Asia, Africa and the Middle East, Northern Europe, Continental Europe, Southern Europe, Central Europe, North America and Latin America. Emerging Asia, Africa and the Middle East, Eastern Europe and Latin America all include emerging markets. Because they lack long-term histories, no frontier markets are included. Some of these groups, such as Emerging Asia, simply includes countries in Asia that have not reached developed status yet, but others show a greater similarity in their history and culture. While there is usually a correlation between the performance of the stocks in the geographical regions that include developed countries, there is usually little correlation between the behavior of emerging market countries.
Asia
Asia has risen in size, in terms of market cap, relative to the rest of the world since the 1960s. Its population is much greater than Europe or the Americas and its GDP is growing more rapidly than the rest of the world; however, its population growth is slowing down. The population of Japan and Korea and soon China are decreasing, not increasing. The Middle East, which includes countries west of the Indian subcontinent is treated as being separate from Asia.
We have divided Asia into three groups: British Asia, Japanese Asia and Emerging Asia. The performance of the three groups is compared in Figure 1. The steep decline in Japanese Asia occurred because of Japan’s defeat in World War II and the inflation that followed the war in the 1940s, but Japan’s market bounced back strongly from 1949 until 1989. It has stagnated since then. Of the three, British Asia has provided the best performance, since it did not suffer from any major declines during the past 150 years.
Figure 1. Stock Exchanges for British Asia, Japanese Asia and Emerging Asia, 1875-2022
British Asia
Four countries are included in British Asia: Australia, New Zealand, Hong Kong and Singapore. Each of these countries were British colonies at some point in the past. Consequently, British common law is used as a basis for legal decisions within each of those countries. The native populations in both Australia and New Zealand were relatively small and those two countries are now dominated by British and European immigrants.
Australia has had numerous stock exchanges in the past. Stock exchanges were set up in Melbourne (1861), Sydney (1871), Hobart (1882), Brisbane (1884), Adelaide (1887) and Perth (1889). In the past, the stock exchanges in Melbourne and Sydney were the largest in Australia. All the stock exchanges merged into the Australian Stock Exchange (ASX) on April 1, 1987. A similar pattern occurred in New Zealand which had exchanges in Dunedin (1867), Otago (1868), Auckland (1872), Wellington (1882) and Christchurch (1900). The regional stock exchanges were amalgamated into the New Zealand Stock Exchange in 1983.
Singapore and Hong Kong were both colonies that became export and financial centers. The Association of Stock Brokers in Hong Kong was set up in 1891 and renamed the Hong Kong Stock Exchange in 1914. The four stock exchanges of Hong Kong formed a unified stock exchange in 1980 and began trading together on April 2, 1986. Hong Kong was an independent crown colony until 1999 when control over the territory reverted to China. Hong Kong is now more and more coming under the control of China making it less attractive to foreign investors since it is becoming more like China and less like Britain. China controls the political situation within Hong Kong. Singapore was once part of Malaysia, but became independent from Malaysia in 1965. All four countries are considered developed.
The performance of the four countries that are part of British Asia is illustrated in Figure 2. Hong Kong performed the best of the four since 1965, but it has stabilized since the 2008 financial crisis. The Australian Stock Market has risen in price steadily since 1965, but the New Zealand stock market has shown little growth since it peaked in 1987.
Figure 2. Australia, New Zealand, Hong Kong and Singapore Price Indices, 1965 to 2022
Japanese Asia
Before World War II, both Taiwan and Korea were part of the Japanese Empire. Taiwan was annexed in 1895 and Korea in 1910. All three countries share not only a common history, but a successful transition to democracy. Each country has relied upon exports as a catalyst for growth. Moreover, there has been a similarity in the performance of their stock markets over the years. All three countries have successfully increased their per capita income to levels similar to some countries in Western Europe. All three should be considered developed economies.
However, this is not true of North Korea and China. North Korea has clearly rejected free markets and trade. Although China has greatly expanded its equity and bond markets since 1990, the markets remain tightly controlled by the Communist government.
The Tokyo Stock Exchange is the largest stock exchange in Japan. It was founded in 1878 and reestablished after the war on May 16, 1949. There is also a major stock exchange in Osaka with secondary exchanges in Nagoya, Fukuoka and Sapporo. The Osaka exchange was established in June 1878 and was reestablished after the war in April 1949. The Taiwan Stock Exchange began operating on February 9, 1962 and the Korean Stock Exchange in 1956.
As Figure 3 shows, all three stock exchanges performed very well between 1967 and 1989. By 1989, Japan had the largest stock market by capitalization in the world, but all three stock exchanges have stagnated since then. Today, Japan’s stock market is about one-tenth the size of the U.S. stock market while Korea and Taiwan are about one-fourth the size of Japan.
Figure 3. Japan, Korea and Taiwan Stock Markets, 1967 to 2022
Emerging Asia
The emerging Asia category includes countries in Asia that still qualify as emerging markets and have not moved on to the developed stage. These countries included both colonies of European powers and countries that remained free of European control. China and Thailand never fell under the control of foreign powers. Although Shanghai had a stock exchange between 1866 and 1949, the Shanghai stock exchange was closed under communism until it reopened in 1990. The Thailand Stock Exchange was established in 1972.
The other emerging markets in Asia were European colonies at some point in time under Britain (India, Pakistan, Sri Lanka, Bangladesh and Malaysia), Spain (the Philippines), the Netherlands (Indonesia) and France (Vietnam).
India, Pakistan, Sri Lanka and Bangladesh were all part of British India until the country gained its independence in 1947. Today, there are only two important stock exchanges in India, The Bombay Stock Exchange and the National Stock Exchange. India has had stock exchanges in Bombay (Mumbai, established in 1875), Calcutta (Kolkota, established in 1908), Ahmadabad (founded in 1906), Madras (1908), Hyderabad (1943), Delhi (founded in 1947), Madhya Pradesh (founded in 1919), and Bangalore (founded in 1957). Other stock exchanges existed in Guwahati, Jaipur, Madras, Pune, Vadodara, Cochin, Ludhiana, Bhubaneshwar, Coimbatore, Magadh, Trivandrum, and Mangalore which were founded in the 1970s and 1980s but have all closed. The Karachi Stock Exchange in Pakistan was established in 1947, the Dacca Stock Exchange in Bangladesh was established in 1954 and trading began in Colombo in Sri Lanka in 1896.
The Malayan Stock Exchange was formed in 1960, and changed its name to the Stock Exchange of Malaysia and Singapore in 1964. When the Malaysian Ringgit and the Singapore Dollar were no longer interchangeable in 1973, the stock exchange split into the Kuala Lumpur Stock Exchange and the Stock Exchange of Singapore. The Manila Stock Exchange was founded on August 8, 1927 and changed its name to the Philippine Stock Market on December 23, 1992. The Jakarta stock exchange was originally opened in 1912, but was closed during World War I and World War II. It reopened in 1952, though primarily to trade government bonds, and began trading stocks in 1977. In 2007, it merged with the Surabaya Stock Exchange to become the Indonesia Stock Exchange. Vietnam did not have a stock exchange until the Ho Chi Minh Stock Exchange opened on July 20, 2000. Stocks for companies that existed in French Indochina traded on the Paris Bourse before World War II, but there was a limited number of French Indochinese companies that listed in Paris.
Africa and the Middle East
Figure 4. Emerging Middle East and Africa Price Index, 1840 to 2022
Only four countries in Africa and the Middle East have had long histories of stock trading. Those four countries are Turkey, South Africa, Israel and Egypt. A securities market was founded in Constantinople (Istanbul) in 1866 to help refinance the debts of the Ottoman Empire. The current Istanbul Stock Exchange began trading securities on December 26, 1985. Stock exchanges were founded in Alexandria (1883) and Cairo (1903). Egyptian and Ottoman shares and bonds traded regularly in both Paris and London up until World War II. At one point, Suez shares had the largest market cap among shares traded on the Paris Bourse. The Johannesburg Stock Exchange was founded on November 8, 1887 and the Tel Aviv Stock Exchange was founded in 1953.
Other countries in Africa and the Middle East have opened their exchanges more recently. This includes Qatar (1997), Saudi Arabia (1980), the United Arab Emirates (1980) and Kuwait (1977) in the Middle East. The second largest corporation by market cap in the world, Saudi Aramco, lists in Saudi Arabia, though it only listed three years ago. Qatar, Kuwait and the United Arab Emirates are also included in the S&P Global Broad Market Index. African exchanges include Nigeria, the Cote d’Ivoire, Zimbabwe, Botswana, Morocco, Kenya, Uganda, Namibia and Mauritius among others, but all of these are small, frontier exchanges with restrictions on the buying and selling of shares.
As Figure 5 illustrates, the stock exchanges in Istanbul, Tel Aviv, Cairo and Johannesburg are so dissimilar that there is little correlation between them.
Figure 5. Turkey, Israel, Egypt and South Africa Price Indices, 1992 to 2022
Europe
Europe has the longest stock market history of any region in the world. Trading in stocks began in Amsterdam when the Dutch East India Company was founded in 1601. Stock exchanges gradually spread throughout Europe, arising in London, Paris, Vienna, Copenhagen and other urban centers.
We have divided Europe up into four groups: Northern Europe, Continental Europe, Southern Europe and Eastern Europe. As Figure 6 shows, the three primary groups have shown similar behavior over the past 220 years, making virtually no progress until 1950, then rising steadily since then.
Figure 6. Northern Europe, Southern Europe and Continental Europe Indices, 1800 to 2022
Northern Europe
Northern Europe includes a number of countries that are dependent upon the seas for trade with the rest of the world. This includes the United Kingdom, Ireland, Sweden, Denmark, Finland and Norway.
Although the London Stock Exchange was founded in 1801, trading in coffee houses had occurred since the 1690s. Shares in the British East India Co. traded before the 1690s, but it was only after the Glorious Revolution of 1689 that formal trading in stocks and bonds began in London. Regional exchanges opened in Manchester (1836), Liverpool (1836), Glasgow (1844) and other cities during the 1840s. The Dublin Stock Exchange was formed in 1793. In 1973, the stock exchanges in Britain and Ireland merged to form the International Stock Exchange of Great Britain and Ireland and in March 2018, the Dublin Exchange was purchased by Euronext. The Copenhagen Stock Exchange began trading in 1808, the Oslo Bourse in 1818, the Stockholm Stock Exchange was founded in 1863 and the Helsinki Stock Exchange in 1912.
As Figure 7 illustrates, the performance of the British, Danish and Swedish stock exchanges has been very similar since 1900, trading sideways to 1950 and rising steadily since them. The Swedish stock exchange has outperformed the other stock exchanges, in part because it successfully avoided involvement in World War II.
Figure 7. Britain, Denmark and Sweden Stock Price Indices, 1900 to 2022
Continental Europe
Continental Europe focuses on the non-Mediterranean countries in continental Europe. This includes Austria, Belgium, Germany, the Netherlands and Switzerland.
The Amsterdam Stock Exchange has operated since 1602 when trading in Dutch East India stock began; the Vienna Stock Exchange has been open since 1771. You can find trading in commodities in Bruges (1285) and Antwerp (1485) even before trading began in Amsterdam. Trading on the Brussels Stock Exchange began with the founding of the country in 1831. Regional exchanges were established in Switzerland in Geneva (1850), Basel (1866) and Zurich (1873). They all merged into the Verein Schweizerische Effektenboerse in 1993.
Germany has a long history of regional exchanges. Trading in commodities and currencies began in many cities in the 1500s, but it was only in the 1800s that trading in stocks and bonds began. Trading in Berlin started on February 25, 1739. As Prussia grew stronger, Berlin became the principal exchange in Germany and remained so until the defeat of Nazi Germany in 1945. Frankfurt once again became the largest exchange in Germany in 1949 and the Frankfurter Wertpapierbörse became the Deutsche Börse in 1993. Trading in securities existed in Augsburg (1540/1830), Bremen, Breslau, Brunswick, Chemnitz, Dresden, Düsseldorf, Essen, Halle, Hamburg, Hannover, Köln, Königsberg, Leipzig, Magdeburg, Mainz, Mannheim, München (1830), Stettin, Strasbourg, Stuttgart and Zwickau. Under the Nazis, the number of exchanges was reduced to nine (Berlin, Breslau, Düsseldorf, Frankfurt, Hamburg, Hannover, Leipzig, München and Stuttgart).
As Figure 8 shows, the country that has done the best of the Continental European countries is the one that avoided any involvement in World War I or II: Switzerland. Switzerland also is home to a number of major multinational companies and its market cap is several times its GDP, which is not true of the other countries in Continental Europe. Both Austria and Germany had the worst performance, primarily because they were on the losing side of World War I and II. The Netherlands and Belgium performed in between.
Figure 8. Germany, Belgium, Austria, Netherland and Switzerland Price Indices, 1900 to 2022
