At one point in relative value investment analysis, using a sovereign region’s borders, particularly in Europe, was an assistant to determine stock selection, a Source Multi-asset research report noted. But in a world of increasingly border-less nations and global trade pacts, is considering a corporation’s sovereign region the best method for stock selection?
A nation’s economic fate was at one point intertwined with stock success to a larger degree
In the past a number of different stock correlation analysis methods using sovereign region were popular. Determining the nation’s likelihood to prosper and then assuming a positive correlation to regional stocks had worked until the mid-1990s, the report noted.
Since the mid-1990s, however, there have been multiple “interesting developments.”
Report authors Paul Jackson and Andras Vig, applying both “top-down” and “bottom-up” analysis, note that both methods point to the same conclusion. Among their more significant conclusions was the finding that prior to the mid-1990s stock performance was highly correlated to a sovereign region’s success, “suggesting country was the most important driver or returns” framed from a correlation standpoint.
What has changed since the mid-1990s is that these positive correlations have become more muted. When considering an alternative method of correlation analysis, sector influence, Jackson and Vig found that this industry variable has become close to a company’s national roots in determining stock price success.
“The standard deviation of returns was higher across countries than across sectors in the 1970s and 1980s but there has been little difference since the early 1990s,” the report noted. “So the opportunity set was once better for country allocators but no longer.”
Analysis: Overlay the larger fundamental trend away from sovereign reliance to recognize why the correlation analysis has changed
This muting of the significance of a corporation’s national orientation has meaningful implications and paints a larger picture of trends in society. What the report didn’t do is take a fundamental overlay of history to look at larger trends driving what appears to be a trend towards “state-less” corporations.
In the 1980s and 1990s it was assumed that US corporations would largely benefit when the US economy benefited. Then in the late 1990s the concept of certain industry sectors – banking, for instance – as being the flag bearer for the US economy was stated as justification for changing derivatives regulation and allowing traditional banks to operate alongside brokerage and other related industries. The link between a corporation’s success and the sovereign nation’s laws – the correlation factor – was reasonably high.
In the mid-1990s a significant change occurred. The research looks at nothing more than the correlation numbers and found a reduced impact of European sovereign regional success relative to stock picking.
In the US at this time, free trade agreements such as NAFTA were setting the stage for a shift supply and demand factors and correlative production costs. The cross-border wage disparity benefited corporations as the significance of national borders diminished. Importantly these are significant political focuses on both sides of the Atlantic and are part of much more significant trends.
Significantly material was that in Europe, where the Source correlation study was focused, the European Union was founded on November 1, 1993. The EU took away a currency advantage that weaker economies might have enjoyed during bad cyclical times, but put on the table the benefit of lowered borrowing costs, unrestricted border crossing and work rules and consistent regional regulation among numerous societal benefits.
Fast forward to today and society is on the verge of a globalized standard for trade that takes this trend much closer to a stage of significant success.
Looking at the Source raw correlation analysis and overlying their conclusion – corporate stock price success is no longer highly correlated with sovereign nation – and then look at the power of the globalization trend. Both of these global trends are highly investiable concepts.