Polson Higgs
International Affairs
Hands up who recalls the Austrian equity boom? (That's Austrian, not Australian.) Yes, the hills were alive with the sound of strong returns early this decade. Want to take any bets about which will be the next country to boom?An historical table of the world's best performing developed markets measured by equity returns shows the land of Mozart and Mahler topped the chart for three consdecutive years from 2002-2004. What's more, it was at number two on the list in 2001 and number three in 2005.
By 2008, however, Austria had slid to last on the table, while Japan, which had been the bottom performing developed equity market in the prior two years, had hurdled to number one.
Clearly, then, picking the country with the best performing market year to year is as hard as correctly forecasting the best asset class or individual stocks.
Yet, there are plenty of people out there saying that now is a good time to start under-weighting the US market or Japan or the UK, because of the effects of the global financial crisis on their economies.
Aside from the difficulty in forecasting, there's another assumption in this strategy of weighting away from or toward particular countries and that is the forward-looking nature of equity markets.
Markets do a pretty good job of reflecting expectations of weaker economic growth in one particular country. So, for instance, if you weight away from the US because you are disturbed by the scale of the downturn in the economy production there, the market almost certainly already reflects that view.
This is why the S&P-500 is more than 50 per cent below its peak. Investors are seeking greater compensation for the risk of investing there.
Likewise, if you are a believer in the 'decoupling' story—the notion that China and the rest of the developing world are growing increasingly economically independent of the US economy, you don't think that's already in the price?
A third problem with the 'picking countries' approach is that the dimensions of individual economies often are unrelated to the pool of investment opportunities in each country.
For example, China may be the world's third biggest economy, as measured by nominal GDP, but ranks in ninth position in terms of the size of its equity market, just below Australia.
Australia, on the other hand, has a share market that punches well above the country's economic weight at 14th position in terms of nominal GDP.
The message here is the need to maintain a disciplined, strategic approach to the allocation of international assets and to base decisions on the investment opportunity, not the size or importance of the country's economy.
A final issue with trying to build an equity strategy around country specific factors is global integration. For example, investors who underweight the US because they are pessimistic about US economic prospects overlook the fact that many of its major companies are multi-nationals.
In fact, S&P has estimated that almost half of the revenue from companies in the S&P-500 comes from outside the US. For instance, Coca-Cola—the world's largest soft drink maker, an American icon and a component of the Dow—also controls just over half of the Chinese soda market.1
So, if you are betting on the China growth story, why would you be making bets against the likes of Coke?
Summing up, it is extremely difficult to accurately forecast which country's equity market will be the best performer from year to year. History shows there is no pattern in returns.
In any case, markets are forward looking. Unless you think that the market mechanism isn't working, it's a fair bet than bad economic news is already reflected in prices. That means expected returns are higher.
Rotating your investments out of a country because of bad economic news just means you end up missing out on a value opportunity.
Your allocation to one country or another should be based on the relative size of the investment opportunity, not on the size of the country's economy. The two are often unrelated.
Finally, global integration makes it nonsensical to express an opinion about a country's relative economic fortunes by underweighting its share market.
1'Coca-Cola to Invest $2 billion in China over 3 Years', Bloomberg, March 6, 2009
With thanks to Jim Parker, Regional Director, DFA Australia Limited for the supply of this article
<< Back to April 2009 News Archive
Last updated: 2nd April, 2009 | 2:45 pm
