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U.S. Equity’ Dominance

Ichiro Suzuki


J.P. Morgan Asset Management recently compiled a report on changes in global equity markets weights by region, dating back to half a century ago. J.P. Morgan thinks that the United States continues to deliver stellar performances after having returned higher numbers than the rest of the world for decades. The country’s lead in AI drives its equity market for the next decade and probably beyond. Innovation, however, is only one of the reasons behind the U.S. market’s superior performances. 


‘Institution’ is as well a big factor as innovation to drive the markets to superior returns. Rule of law is firmly in place and property rights are well protected. This is not always the case in the developing world though it may be taken for granted. On top of it, Corporate America is managed for shareholders more than anyone else. It is so even if stakeholder capitalism may have become a vogue in recent years. This is not always the case elsewhere. In the European Union the bloc’s penchant for regulation doesn’t help its markets. Whereas the U.S, leads the world in innovation, the EU leads in setting new rules and regulations so that its economies don’t become Wild West, trying to set standards that can be applied globally. The bloc’s ambition is becoming a regulatory superpower. While regulations are necessary, too strict ones work against investment returns. 

 

The EU’s structural flaws in the region is suppressing equity market returns, too. Europe is too fragmented, consisting of a number of countries. Each country has its own national budget, regulations, telecom system, banking system, etc. Fragmentation is giving corporations a harder environment do business, and a national champion in each country is operating in sub-scale, leading to lower profitability, and hence valuation of their stocks. In addition, Germany, the biggest economy in the region, is struggling for its own structural problems, contributing another factor to drag down the region’s growth.

‘Others’ region is essentially represented by what is often called ‘emerging markets’, in which Asia has dominant presence. At the outset of the 1990s, Asia was widely believed as the growth engine of the world in the 21st century, drawing a huge amount of capital into the region. In 1993, the East Asian markets commonly doubled, as a harbinger to what was expected to come in the next century. Then, the region was brought down by the Asian Financial Crisis in 1997-98, which sent their economies into a depression and decimated their equity markets. East Asia recovered in the 21st century as an export machine to the U.S., and also took advantage of spectacular growth in China. After the Global Financial Crisis in 2007-09, however, the region’s economies slowed down considerably. Asia is more fragmented than the EU, with the Association of Southeast Asian Nations  (ASEAN) being a much looser regional bloc than the EU. The ASEAN doesn’t include larger Asian economies such as South Korea and Taiwan. Smaller size of domestic economy stands in the way of growing world class corporations that win in global competition. In the old days, when Japan was the second largest economy after the U.S., manufacturers that survived fierce competition in the domestic market succeeded in the export markets. Experiences in the domestic market contributed to lowering their fixed cost base for Japanese manufacturers, giving them cost advantages in overseas markets. Manufactures in smaller Asian countries were not in a position to replicate this strategy. On top of it, Japanese companies deployed their factories throughout East Asia in a relatively short period of time, probably denying local manufactures’ chance of growing to be global players. That said, several companies went against the odds with unique technology and became global giants. Taiwan Semiconductor grew to be a trillion dollar company in its equity market capitalization. South Korea’s Samsung was at one point one of the world’s ten largest companies. Hyundai Motor is one of the largest car makers. There have been no such companies from the ASEAN. That’s as far as East Asia went.


For this matter of size, Chinese companies, notably those in the tech field, rose meteorically on the basis of a huge domestic market that is the second largest. Chinese tech titans were, however crushed by President Xi Jinping’s irrational and hysterical decree against wealth creation, especially that by tech entrepreneurs. His unfettered anti-capitalist conduct has ruined China’s equity market. Prior to ‘common prosperity’, wealth creation in China already lagged growth of the Chinese economy. J.P. Morgan expects China to do well in the next decade, reversing the anemic trend in recent years. For this to happen, Xi Jinping’s policy of ‘common prosperity’ has to be scrapped. Replacing Xi with more pragmatic leader would greatly help both the economy and the market. It seems like a long shot, however, at this juncture.


Finally, Japan went through its rise and fall over the last half a century. Super-normal growth of the Japanese economy in the 1970s and 1980s drove the Tokyo market to dizzying levels. Value of the market was inflated by mutual share holdings among major Japanese corporations. A long-time boom has culminated in a historic bubble in the late 1980s. For a fifteen months period through January 1990, market capitalization of Japan exceeded that of the U.S., as a showcase of the enormity of the bubble. Japanese corporations dominated the list of the world’s largest companies back then. At the end of 1993, four years after the height of the bubble, Japan still represented a considerable portion of the global equity markets. It had much further to fall through the end of the first decade of the 21st century. On top of the struggling economy, dissolution of mutual share holdings increased equity supply, exerting further downward pressure on prices. The market has finally bottomed in the early 2010s, as genuine political efforts to fight the persisting deflation had started. Corporate Japan began to embrace shareholders’ value, shifting somewhat away from stakeholder capitalism that dominated the management class’s value for a long time. Their operations are more focused in recent years, and cash has been returned to shareholders. Japan is in the process of a slow but steady comeback though the economy grows only slowly.


About the author: Mr. Suzuki is a retired banker based in Tokyo, Japan.


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