The broken relationship between market-cap and GDP

"Plus ça change, plus c'est la même chose". "The more things change, the more they stay the same" is an aphorism written in 1849 by French writer Jean-Baptiste Alphonse Karr.

The MacBook Pro is the only Apple product manufactured in the USA. Currently, total sales of Mac computers account for less than 10% of Apple's revenue, with the MacBook Pro representing slightly more than half of Mac computers' sales.
More than 60% of Apple’s revenues come from outside the USA. While the Apple ecosystem has generated millions of jobs worldwide, fewer than 200,000 people are employed by Apple within the USA.

In summary, Apple’s growth has not led to large-scale employment or significant boosts to GDP in the USA, nor is it solely dependent on the American economy. The largest beneficiaries of employment generation have been in China, where the Apple ecosystem has created over 4 million jobs.

Their India operations are expected to create 600,000 jobs by the year end. Better economic growth in India and China helped Apple’s growth, by creating demand. But the world's largest company by market capitalization adds to NASDAQ and USA’s market cap!
Given these shifts in the global economic landscape, it's worth questioning why we continue to rely on the home country’s GDP growth as a predictor of stock market direction and valuations. Traditional methods may no longer be as reliable in today’s interconnected and rapidly evolving world.

The ever-reliable Buffett indicator is flashing red in the USA. The market-cap-to-GDP ratio has reached an all-time high of 2x, significantly exceeding the 1.4x ratio observed just before the GFC crisis in 2008 and the dot-com bubble in 2000. India is also in the elevated zone with a ratio of 1.3x, the highest in over a decade, but still lower than the 1.7x recorded in 2008 and the 2.2x peak in 1992.

In a recent article (Superstars for too long: Time to move away from India, US equity markets), Akash Prakash of Amansa Capital contemplated whether these two darlings of the world stock markets (USA and India, with 20-year USD-denominated returns of 12.8% and 10%, respectively) are about to peak out. One of the most acclaimed thinkers of our time, Ruchir Sharma, is predicting the US’ golden era may be over. He forecasts in his article, ‘The world should take notice - the rest are rising again’, that emerging markets with their better growth, more robust balance sheets, and prudent fiscal governance are poised to outperform, reversing the last four decades of American dominance of equities (the US market-cap is now two-thirds of the world market-cap).

However, I would question both of these conclusions. As demonstrated by Apple’s example, increasing corporate earnings and market capitalization are diverging from the home country’s economic fundamentals. This trend is evident in many economies.

There are three reasons for this broken linkage: global production, global markets, and capital allocation.

Global Production: Electronic manufacturing is benefiting the Indian job market and, consequently, the Indian economy. In FY25, India's electronics exports are estimated to reach $25 billion, nearly five times the amount from a decade ago. Additionally, $14 billion worth of iPhones are now assembled in India.

According to government reports, approximately 2.5 million people are employed in electronics manufacturing in India, with a target to double this number within five years. In comparison, China and Taiwan have significantly higher employment figures in this sector. Apple’s increased investments and growth, therefore, do not substantially benefit the US economy.

While most Apple suppliers operate with profit margins of less than 5%, Apple's margins exceed 30%, capturing most of the value (market cap) in the USA. Additionally, 68% of US companies outsource at least some of their production globally. This approach has benefited global GDP and American market cap over the past 2-3 decades.
Global Markets: According to Bloomberg, 40% of S&P 500 companies' revenues now come from the Rest of the World (ROW, excluding the USA). This figure was 30% a decade ago and likely less than 20% two decades ago. For large tech companies, the ROW percentage is even higher, at approximately 60%. The largest luxury products maker, LVMH, generates more than 40% of its revenues from outside Europe and the USA. Strong growth in China has benefited LVMH more than it has benefited Chinese companies. Over the past 20 years, LVMH’s stock has delivered annual USD-denominated returns of 15%, outperforming both the Nifty and the S&P 500. It is also Europe's second-highest market-cap company.

Capital Allocation: This is my favorite point and most relevant for India. There is a clear positive correlation between capital allocation and market capitalization; however, there is also a negative correlation between capital allocation and a country's GDP growth.

Indian companies have increasingly focused on market capitalization and shareholder returns, demonstrating superior capital allocation discipline. In contrast, Chinese companies have historically prioritized scale over return on capital. Similarly, Korean and Taiwanese companies have also pursued scale in the past.

These countries built larger-scale companies, which created employment and drove GDP growth. While Indian companies' stock prices have performed better, their measured expansion results in a lesser impact on employment creation, ecosystem linkages, and export potential, thereby providing less leverage to the nation’s GDP. Consequently, better capital allocation leads to a smaller GDP but a larger market cap.

Is there, therefore, a trade-off between faster GDP growth and the market capitalization or valuation of a country’s stock markets? The China+1 opportunity has been significant since the GFC and has been accelerated by the new ‘Cold War.’ Yet, countries like Vietnam, Bangladesh, and Indonesia have been more successful in increasing their share of the China+1 market. Whether measured and steady growth with superior capital allocation is more beneficial in the long term is a topic for another discussion.

I want to add a fourth dimension to the market-cap argument—innovation and branding. Both create competitive moats and pricing power. The USA leads in innovation, and with India’s burgeoning start-up culture, we are beginning to make strides in this area as well. Korea and China have successfully established global brands, such as Xiaomi, BYD, TikTok, and Samsung. While India has developed many strong domestic brands, we have yet to make a significant global impact. Foreign brands are still often perceived as superior in India. To sustain the Indian stock valuation premium (with MSCI India trading at a 78% premium to MSCI EM), addressing the brand's logjam will be crucial in the long term.