Shifting Focus: Behind Country Valuations Today (ENOR, ERUS)
Russ Koesterich: As the European financial crisis raged last fall, investors were closely monitoring metrics like credit default swaps and yields on Italian bonds to determine where to place their country bets.
But 2012 has brought some stability to the eurozone and with it we’ve noticed a shift in the types of indicators that investors should be tracking when it comes to determining country valuations — metrics that show economic growth.
Yes, investors have always kept an eye on economic growth by tracking metrics like leading indicators, retail sales and industrial production. But what Nelli Oster, an investment strategist on my team, has noticed is that over the last six months, the sensitivity of country valuations to economic growth expectations has intensified.
Perhaps six months ago investors were too consumed by worries over European solvency to focus on economic growth. But today, that appears to have changed as those worries have lessened and as economic growth has become more varied and harder to find.
Nelli’s research shows that the country valuations have become more sensitive to how the near-term growth prospects for a country compare to past trends. Take China as an example. In early March, the Chinese government modestly lowered its annual growth target to 7.5% from 8%. While that is still a very healthy pace compared to the developed world, it left investors more worried about a slowdown in China — and the MSCI China index fell 6.9% in US dollars in March.
Nelli has also found that the valuations of developed market countries have become more sensitive to absolute growth levels, or how the near-term growth projection for a developed country compares to those for other developed markets. The growth projections Nelli analyzed were garnered from leading indicators.
She also noted that there’s more variation in growth rates. Countries such as the United States, Mexico and Japan are expected to grow faster relative to their past trends than six months ago, while prospects for countries such as Italy and Belgium have deteriorated. As growth is more difficult to find, investors seem willing to pay a larger premium to access it.
For investors, the intensified emphasis on growth means that in coming months, faster growing countries will likely be rewarded with higher returns, and the difference in returns between faster growing countries and slower growing ones will likely stay elevated.
Of countries expected to fare well relative to their past growth trends – also taking into account valuations, corporate sector profitability and riskiness – I hold overweight views of Norway and Russia. Of countries expected to slow down further, I hold underweight views of Italy and India [potential iShares solutions: iShares MSCI Norway Cppd Investable Mkt (BATS:ENOR), iShares MSCI Russia Capped Index (NYSEARCA:ERUS)].
Sources: Bloomberg, Worldscope
Disclosure: Author is long ERUS
International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume. Securities focusing on a single country may be subject to higher volatility.
Russ Koesterich, CFA, is the iShares Global Chief Investment Strategist as well as the Global Head of Investment Strategy for BlackRock Scientific Active Equities. Russ initially joined the firm (originally Barclays Global Investors) in 2005 as a Senior Portfolio Manager in the US Market Neutral Group. Prior to joining BGI, Russ managed several research groups focused on quantitative and top down strategy. Russ began his career at Instinet in New York, where he occupied several positions in research, including Director of Investment Strategy for both US and European research. In addition, Russ served as Chief North American Strategist for State Street Bank in Boston.
Russ holds a JD from Boston College Law School, an MBA from Columbia Business School, and is a holder of the CFA designation. He is also a frequent contributor to the Wall Street Journal, New York Times, Associated Press, as well as CNBC and Bloomberg Television. In 2008, Russ published “The ETF Strategist”(Portfolio Books) focusing on using exchange traded funds to manage risk and return within a portfolio.