How is GDP related to the stock exchange

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easyfolio pursues an ETF-based investment strategy. The aim is to allow investors to easily and transparently participate in global economic growth. There are different approaches to how the investment capital can be allocated to individual countries and regions in order to reflect global economic performance as accurately as possible. In this article we introduce two methods of country allocation. On the one hand, the allocation according to market capitalization and, on the other hand, that according to gross domestic product (GDP). Then we will examine the respective advantages and disadvantages.

Weighting according to market capitalization

A common method of country allocation is weighting based on market capitalization. Traditionally, market capitalization is used to capture the size of the capital markets of individual countries and to determine their share in the global capital market. The market capitalization of a country is to be understood as the total value of the companies traded on the stock exchange in this country. Accordingly, the market capitalization of an individual company represents the number of its shares in free trade, multiplied by the current market value of the share. The market capitalization describes the value of a listed company depending on the current, constantly changing market situation. The value of the companies traded in that country can therefore be used as an approximation for the size of a country's capital market.

The largest capital market in the world by market capitalization is in the United States, which is due to the sheer number and size of public companies that trade there. In practice, this dominance of US stocks can be explained using the well-known MSCI World Index, which contains more than 1,600 stocks from 23 industrialized countries and these countries are weighted according to their market capitalization. The share of US stocks in the MSCI World Index is just under 60 percent, followed by Japan with almost nine percent and the United Kingdom with a share of around 6.5 percent. Germany's share, on the other hand, is almost four percent. The development of this index is therefore heavily dependent on the development of the stock market in the USA.

This observation can also be transferred to other indices, such as the MSCI All Country World (ACWI) index. In addition to the 23 industrialized countries, this index also includes 24 emerging countries and contains more than 2,400 stocks. The index is therefore a good approximation for the country breakdown of the global stock market. But even here, US stocks predominate with a share of a good 52 percent. Both indices thus paint a uniform picture: in terms of market capitalization, the USA is still the largest stock market in the world. In comparison to their economic output, however, the emerging countries are given little weight. China, for example, only has 3.5 percent.

GDP weighting

If one looks at gross domestic product (GDP) instead of market capitalization, a more differentiated picture emerges, since economic strength comes to the fore here. In order to measure the economic performance of a country, the GDP is usually used. The GDP, also known as “Gross Domestic Product” (GDP), reflects the total value of all goods and services that are produced within the national borders of an economy over a period of one year. Among market participants, GDP is considered to be one of the most important key figures and is used as a measure of the growth of countries and entire regions.

The World Bank regularly publishes statistics on the economic performance of individual countries and economic areas. Using these statistics, the US is still the largest economy in the world, closely followed by China, Japan, Germany and the UK. However, the US share of global GDP is significantly lower than its share of global market capitalization and, at just under 25 percent, less than half as high. This difference arises from the fact that the capital markets in many emerging countries are not yet sufficiently developed and companies from these countries prefer to trade in the USA and Europe.

Nonetheless, emerging countries have an increasing share of global economic power and often have higher economic growth than industrialized countries. This development particularly affects the Asian economic area, above all the People's Republic of China. In the past two decades in particular, the emphasis has shifted significantly in the direction of emerging markets. This development should be taken into account in a global portfolio.

easyfolio investors benefit from the BIP method

So there are two methods available to weight countries in a global portfolio. A weighting of the countries according to their market capitalization reflects the global capital market more precisely. However, the economic performance of companies that are not traded on a stock exchange is not included in this calculation. In Germany in particular, however, it is not only the listed companies, but above all the medium-sized companies that are considered to be the key drivers of economic growth. All companies in a country contribute to economic performance, regardless of whether they are accessible to public or only private investors. Also, many markets in the emerging countries are not yet sufficiently developed, are not liquid and are therefore only available to investors to a limited extent. This is where the GDP method offers a decisive advantage by taking into account the economic performance of all companies in a country. As a result, emerging economies in particular are given greater weight, which means that investors can benefit from the high economic growth in these regions. Although the capital markets in emerging countries are generally more volatile, the GDP method allows for much greater diversification.

With all easyfolio strategies, the investment markets are weighted uniformly according to the gross domestic product within the defined equity ratios of 30, 50 and 70 percent. The share of countries and regions in the portfolios is therefore based on their share in global economic output. This weighting enables a more balanced portfolio with lower cluster risks, as the US in particular is given a lower weight. The official information from the World Bank is used to calculate the weighting. The high level of diversification enables easyfolio investors to benefit from global economic growth - including transparency and cost efficiency.

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