Do countries still matter in global investing?

Do countries still matter in global investing?
They do, but sector influences are gaining significance.
Sandra Yeager, Senior Vice-President, Alliance Capital

Do countries still matter or are sectors obtaining more significance? The initial conclusion on a global basis is that sectors have become more important in driving global share price performance, particularly in the 1990s. Recent research from Goldman Sachs suggests that global sector industry influences on share price performance have increased at the expense of local country influences--especially in the last two years.

The research involved running several regression models of over 2,000 stocks in the FTSE World Index. Stock returns were broken down into four components: 1) global markets effect; 2) local market; 3) global industry; and 4) stock specific.

The global sector effects accounted for 8% of individual stock performance back in June 1995. Local market effects accounted for 20%. Global market factors accounted for an additional 18%. Stock-specific influences accounted for the remaining 50%.

By December 2000, the global sector influence had increased to 20%, and was more important than either local market influence at 9% and global market effects at 11%. The stock specific influence increased slightly to 60%.

A further study outlined in the September/October 2000 edition of the Financial Analyst Journal also shows this trend of growing industry influence on stock price performance. The research involved looking at 52-week moving averages of industry and country mean absolute deviations from the index return in order to measure the relative importance of industry and country factors. For most of the 1990s, country-based tilts dominated industry-factor tilts. That trend reversed in 1997 with industry dominating countries.

These studies have been global in scope. As we look at smaller regions around the globe, we find conflicting data. Europe has greatly influenced the global data we have seen; and sectors definitely matter more than countries in attributing stock price performance.

A Morgan Stanley study looks at R-squared co-efficients of one- and two-factor regression models. Since mid-1996, the explanatory power of the industry one-factor model has taken off while the one-factor country model has deteriorated from its highs.

Stepping back from the data and thinking on a more basic level, the increasing importance in Europe of industry versus country seems reasonable. With the advent of the European Monetary Union (EMU), there is a single currency, the euro, along with a convergence of interest rates. Fiscal and monetary policies are decided in aggregate with fewer local effects. The de-regulation and privatization of industries, in addition to tax and pension reform engendered through EMU policies, have all contributed to Europe being more united and less nationalistic.

Asia, on the other hand, is a mixed picture. Countries still play an important role in stock price performance, particularly for the emerging markets.

Another Morgan Stanley report shows that in Asia Pacific, country factors strongly explain stock price performance versus sector factors. Although recently, sector factors have been gaining in importance.

Reasons for such dominant country factors in Asia relative to Europe are that economic integration within Asia is far lower than in Europe. Although some Southeast Asian countries have been trying to come together, there is still no Asian version of EMU. Intra-regional trade in Asia as a proportion of total trade is only in the mid-30% range (versus 60% in Europe). The political landscape is far more diverse, and while developed countries such as Australia, Singapore and Hong Kong may be similar in economic policies, China and India are definitely worlds away.

Thus countries still matter, but sector influences on stock price performance are gaining in significance.

Contex Group