Why you should buy stocks in China and India-and sell all your developed market stocks (or short them)

In this post, I will try to prove to you that at this time, it makes sense for you to buy China and India stocks, and sell every developed country stock you got. If you are more adventurous, sell the developed country stocks short and use the cash to buy China and India stocks.

Let me introduce you to two graphs first.

The first graph shows no. of High Net Worth Individuals (HNWI) (People over USD 1 Million dollars in assets, excluding their house) in selected developed countries (note at bottom on why this selection) and the population of these countries. Data is from 2006 and 2005 (extrapolated).

The second graph shows their total stock market cap plotted against the country's population. Data is from 2006 and 2005 (extrapolated).


As you can see clearly-the stock market cap of a country and the number of HNWI in it are proportional to the total number of people in the country, to a very good approximation.

Also note that most HNWI invest in the stock market, so the above graphs are really one and the same thing-just showing clearly the correlation of wealth to population.

I am omitting a graph here-that the GDP of these countries also scales well with their population (the correlation is not as good as in the graphs above. I don't trust GDP calculations very well, because there are different methodologies of calculating GDP followed in these countries)

Now we go back to some basic stuff. What are we doing when we buy stocks? We are essentially buying human creativity, producivity, the ability of human beings to make the world better for themselves, individually and collectively. Economics tells us that selfishly working for themselves, trying to make more money for themselves, humans do a lot of good for each other indirectly-and I believe it was Milton Freidman who argued that that was really the best way to do collective good-to work selfishly for your own interest.

Essentially, when you put money in the market, on a major index like the SP 500, you buy the raw power of 300 Million Americans working for you. The point I want you to take from here is-you are investing in humans first, then the sectors/industries/hot areas/growth stocks, etc. I will call this theory of mine the "human capital" theory of investing.

In a free market economy-humans will find out the best way to allocate capital, and themselves, to produce the most. That is why stock market capitalization of the five developed countries above are proportional to the number of people they have. A fraction of these people becomes millionaires, and the number of these HNWI is also proportional to the total population of the country. It intuitively makes sense.

Go back 20-30 years ago. China and India were not open markets, socialism and government control was making massive mistakes in allocation of capital. Same goes for other emerging markets like Russia and Brazil. We had a problem-free markets were not allowed to operate in the "developing" countries-mostly by rogue or unknowledgeable governments.

When free markets were embraced in China and India, the world there suddenly changed. The State was not fixing prices-it was letting the market economy decide where to best allocate capital and human resources.

Since India has 1.1B people, and China 1.3B people, given that free markets are going great in these countries now, and private industry is increasing it's share of economy-it is very likely that these two countries will become "developed" countries in the years to come. The Goldman 2003 report and it's subsequent updates give some timelines to that-that China will be the biggest economy of the world by 2030-2040, India will be second, etc.

Since GDP/Overall Stock Market Cap/No. of HNWI are proportional to the population of a country, in a free market economy, it is obvious that the richest people and the biggest stock markets in the next few decades will be China and India( I actually think that the Goldman report is underestimating how fast these countries will come up-I believe by 2020 China will be the world's biggest economy, and by 2025, India will be the second biggest economy of the world..with the related increase in total stock market caps and No. of HNWI. Note that this can happen if the countries mentioned above go into a recession-one side can start losing and the other side (India and China) can gain).

So fast forward to 2025 AD.

The top two economies of the world will be China and India. These will have the biggest stock market caps of the world country stock market caps, and will also have the highest number of HNWI.

USA today has a market cap of 16 Trillion Dollars with 300Million population.

China is a market cap of 2 Trillion Dollars (approx-including some of Hong Kong) with 1.3B people.

India is a market cap of 1 Trillion dollars with 1.1 Billion people.

A possible scenario in 2025 (or whenever China and India will become "developed" nations):

China Market cap 120T
India Market cap 100T
USA market cap 30T

The growth in the stock market caps (and therefore a well diversified portfolio in each of these countries) will be fastest for China and India. Your investment money today will go much farther in these countries than the developed countries mentioned above.


Why did I choose these five developed countries and not others? Because they are the biggest developed countries, and also because stocks of these countries are primarily owned by local investors.

This argument can be extended to prove why the developing world returns (emerging market returns) will grow faster than the developed world.

As capitalists, or owners of capital, people like you and me can move our money around much faster than GM or F actually shutting down their facilities and only importing Chinese and Indian cars. Capital goes where returns are-you know that you want to invest in China and India-because that's where the "human capital" is.

A couple of other things:

Other developing countries are great to invest to-but they will saturate out because of limited human capital.

Countries which hold resources of value to China and India-Brazil, Russia, Australia and Canada, raw materials which can't be easily duplicated by the Chinese and the Indians, will prosper the best by selling the raw materials to China and India. The information edge, the soft power, of USA, UK, France, Germany and Japan is largely going to be gone because of development of markets in China and India. Some companies like Microsoft are likely to prosper-but anything which is "physically manufacturable(Airplanes, pharmaceuticals)" and "not-an-addiction (Windows)" will move over to China and India.


Sanjay