Friday, November 22nd, 2019

Where Have All the Leaders Gone?

If the Gods Had Meant Us to Vote, They’d Have Given Us Candidates is the title of a book about the US Presidential election in 2000, by the otherwise unknown US writer, Jim Hightower. We wonder if he would have felt the same way about the current UK election, but we actually want to apply this quote to the current state of financial markets. If the Gods had meant us to buy global equities, they would have given us some leaders. Our All-World Country Report looks at 44 developed and emerging equity markets and it has rarely been so short of potential buying opportunities in its entire 25-year history.

Before we discuss the conclusions, we need to spend a little time on the structure of this report. We compare each country against a global equity index excluding the US. (1) This stops the exercise being dominated by the performance of US equities. (2) It also provides a more useful comparison for the US. We ask the same question as always, “What is the probability that the total return from a specific country will beat the total return of the global index by a margin, which is more than the excess volatility from investing in the country rather than the world index?” Over the long run, the global index will tend to have lower volatility than the average of the individual countries, so we would always expect to have slightly more underweight than overweight recommendations.

Our report also calculates a leading indicator for each country. If the probability of out-performance based on recent data is better than that based on long-run data, this has a positive score. If it’s the other way around, it has a negative score. We then use a traditional quadrant approach to highlight countries with a high probability of outperformance and a positive leading indicator. This is the top-right quadrant, referred to as Zone 2 on our chart. Countries we want to avoid are in the bottom-left (Zone 4). We also add a Zone 0, comprising uninteresting countries, with readings close to the origin on both measures.

At the moment, there are only three countries in Zone 2: Japan, Taiwan and Portugal. This is not the lowest ever reading over 25 years. There have been a few weeks with none – i.e. several countries in the top-right quadrant, but all too close to the origin and therefore in Zone 0. Nonetheless, it is very disappointing. The situation is worse when we include Zone 1 (low probability and positive lead indicator) and Zone 3 (high but negative). The number of countries in Zone 1 is also below its long-run average, while the values for Zone 3 and especially Zone 4 are well above theirs. If we apply a simple scoring system to the number of countries in Zones 0-4, we arrive at a current score of -15.5, against a 25-year average of -1.6. Two weeks ago, the score was -16.5, the lowest score since May 2000.

A low score can mean that global equity markets are closely correlated with each other – which limits the opportunities for effective diversification. It can also mean that there is a lot of rotation between countries, which puts undue emphasis on market timing. Either way, it is not an attractive environment in which to run an active regional allocation process. So, if like us, you are struggling to come up with good ideas, don’t worry. It’s official: there are no candidates. Except, of course, Japan, which has been in Zone 2 for the last eight weeks, even though nobody seems to care.

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