By Robert Casoni, head of European smaller companies research at SchrodersSalomonSmithBarney Sin...
By Robert Casoni, head of European smaller companies research at SchrodersSalomonSmithBarney
Since the European Monetary Union (EMU), investors have downplayed the country effect and focused upon sector effects in building portfolios.
Our European strategy team has pointed out recently that evidence this year suggests that country effects are regaining impact.
Note the underperformance of Germany, down 45% year to date, compared with Switzerland down 24%, almost equivalent to the underperformance of the energy sector relative to the telecom sector.
So, what are the explanations? The move by fund managers to focus on sector calls became self-reinforcing as more investors looked at relative returns between sectors and these naturally became the dominant variable in explaining returns.
Arguably this was also a statistical side-effect of the technology, media and telecoms bubble ' a sector-driven phenomenon.
It could simply be that the relative country returns have been neglected and that this has created a trading opportunity to play unrecognised national economic divergence in 2002.
But is it just a trade? After the EMU, a single monetary policy and fiscal policy, kept within the straightjacket of the Stability Pact, meant that economic performance was expected to converge in the eurozone.
However, the markets have just woken up to the fact that this is not necessarily the only possible outcome.
Without the use of monetary and fiscal policy, or the flexibility of a floating exchange rate, there are few ways that geographic economic imbalances in prices or demand can self-correct. As a result, when there are negative imbalances, such as those developing in Germany today, the consequences can develop more slowly than a currency crisis, but can become more deep-seated and self-reinforcing.
These economic fears are now feeding into the equity market, particularly through the fear of deflationary effects on the financial system and financial stocks.
There has been a relationship between GDP growth and stock market performance.
Spain and the UK are among the fastest-growing economies in Europe this year and among the best-performing stock markets, with Germany and the Netherlands at the other end of both rankings.
It is almost as if old-fashioned currency or bond volatility is now being transferred into the equity markets especially via domestically-oriented financial sectors and mid and small-caps.
According to Bloomberg, in the year to 1 November the FTSE Latibex All-Share Spanish Index fell 2.85% in sterling terms.
Over the same period the Amsterdam Exchanges Index fell by 1.36% and the Irish Overall Index fell by 2.98%.
Country effect calls offer opportunities.
Spain and UK fastest growing countries.
After EMU, markets have opened up.
Por performance from Germany and Netherlands.
Increased equity market volatility.
TMT boom was sector specific.
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