If you happen to tune into the financial media (and we don’t recommend it!), you will undoubtedly hear frequent references to “the market”. The reporters and commentators will discuss not only what “the market” did, but also how it looks to them, and even how it feels, as in “the market looks strong”, “the market appears tired here”, “the market needs to consolidate its gains”, or my favorite “the market really wants to go up (or down)”. Of course, the “market” is rarely defined on these shows, but usually they are referring to US stocks, and often just a particular index like the Dow Jones Industrial Average or the S&P 500. But is that “the market”? If not, what does “the market” really look like?
To answer that question, we’ll need to look at some data. As evidence-based investors, we know that there is a tremendous amount of information incorporated into the prices of publicly-traded securities. Each individual stock or bond price can be thought of as the sum total of all investor participants’ opinions on the fair value of that security – the best guess if you will, of its future cash flows (dividends or interest payments). Those anticipated cash flows are then “discounted” both by inflation expectations and by the likelihood of actually receiving those cash flows to arrive at today’s market price.
When these market prices are multiplied by the number of shares (or bonds) outstanding, we can determine a company’s size (also called its market capitalization). Next, by summing up the sizes of each individual company, we can determine the overall size of stock (or bond) markets, countries, regions, and entire asset classes.
Now we can begin to define “the market”. Are we only looking at stocks? In that case, the ‘market’ contains many thousands of individual securities (most of them small firms located outside of the US). While the majority of world stocks are located and traded outside of the US, the United States still accounts for about 52% of the total dollar value of all world stocks combined. (Companies in the US are much larger, on average, than in other markets). Foreign developed markets, such as Japan, Germany and the U.K. make up about 35% of world market value and emerging markets such as Poland, Brazil and China represent another 13%.
But maybe we should include bonds as well – they are, after all, another major asset class. In fact, the global bond market, at over $100 trillion, is much larger now than the global stock market (about $64 trillion). If we were to include just four asset classes (US stocks, non-US stocks, US bonds and non-US bonds) in our definition of “the market”, and weight them according to their current dollar values, our representation of the market would look roughly like this:
Non-US bonds (42%), US bonds (30%), US stocks (14%), Non-US stocks (14%)
Note that US stocks are now only 14% of the total! However, this definition of “the market” is still incomplete because it actually excludes the largest single asset class, which is global real estate. But even if we only include the “investable” portion of residential and commercial real estate (excluding properties such as Yellowstone Park and the Eiffel Tower which are valuable but not for sale), it still becomes a very significant 31% of our more comprehensive definition of ‘the market’. Global bonds would now represent 49% of the total market and the weighting of global stocks would fall to only 19%.
You may be wondering “What about commodities?” Interestingly, the ‘investable’ portion of worldwide commodities is remarkably small — at around $1 trillion, gold represents only about ½% of the total market and all other commodities (energy, agricultural, metals, etc.) only account for about 0.1%. As it turns out, the asset class weights in our latest definition of ‘the market’ are not really affected whether we include commodities or not.
As you can see, there are many ways to represent “the market” and not everyone agrees on a single best definition or which asset classes to include. Stocks get most of the attention in the financial media, but only represent about 1/5 of total investable assets. The most important thing to keep in mind is that “the market” represents the sum total of all investors’ opinions as to the relative values placed on each individual security or investment. Collectively, the wisdom of the crowd determines prices, and thus values and sizes of each asset class.
DFA 2016 Matrix Book