Why countries, not companies?” That’s the question that a colleague put to me early this week. He had seen the work I’ve spent the last few years doing, which values stocks and bonds based on their country of domicile, and that seemed strange to him. If you work in retail finance, almost all the analysis and valuation you’ve seen in your lifetime is an attempt to choose one American stock over another. Institutional investment analysis adds the bond (usually American) option to the analysis. Financial TV shows ask their guests for ‘some names’ by which they typically mean names of companies to invest in.
And all of that makes a kind of sense: From the time of the Reagan revolution until 2007, the main question really was ‘which American company should I buy?’ But that doesn’t make sense any longer. The Reagan revolution is over and, to some extent, it’s even been reversed. America spent much of the 80s among the top five on the list of freest countries in the world. Now it’s barely in the top twenty.
My friend Ted Lucas from Lattice Strategies sent me a slew of papers this week all using rigorous data to show the same thing. (You can find them here:MSCI- The Relative Strengths of Industry and Country Factors in Global Equity Markets andAccuvest – Global Equity Investing: Do Countries Still Matter? and MSCI – Global Equity Allocation: Analysis of Issues Related to Geographic Allocation of Equities.) Ted puts it this way: “You can influence the returns and risk of an equity portfolio in basically in three ways. One is company selection. Another is sector allocation. Another is how the portfolio is positioned across countries. Over longer periods of time, the latter appears to have the greatest impact.” In other words, over the long haul in a diversified portfolio variations in country performance tend to count more than variations in company performance.
That’s about right. The research that I’ve seen shows that ‘alpha’ (which basically refers to return differential, but is usually used to describe excess returns, or over-performance) is not mainly a factor of individual company choice. Which sector the company is in means quite a lot. But the data that I’ve seen says that when it comes to evaluating risk and return, the country of domicile and the state of the world economy mean even more. In other words, regime risk and global systemic risk are in the driver’s seat, with sector membership riding shotgun and company choice in the backseat.
Yes, you can choose an Apple or Microsoft in its infancy, and a few people do. But even in that case, the risk of concentration is massive. It seems that country selection is a better source of alpha than company selection.
My colleague suggested that since there is so much data available for companies, this posed an advantage for company-based analysis. The problem with that is that the data most available for companies over long periods of time is price data. The financial industry is obsessed with price data. The problem with this obsession is that prices are epiphenomenal. Prices are an effect, not a cause. Patterns of human action ultimately determine the pricing. These patterns are things such as the quality of leadership decision in a company, details of internal operations, etc., none of which is included in pricing information and much of which is not publicly available.
On the other hand a small army of economists, analysts and data jockeys are employed by the governments of the world, private think tanks and multilateral institutions like the IMF and the World Bank to track every aspect of national economic life: debt, demographics, budgeting, taxes, as well as cultural, religious and educational factors. By its nature, such information is public, while company data by its nature is proprietary and shared only when the company is forced to by law or self-interest. For this reason, we have far more readily available information about the economic environment of business than we do about the businesses themselves. And I’m fine with that because I think environment is the most important thing.
Remember the story about the drunk who was searching for his car keys under the streetlamp?
“Is that where you dropped them, Joe?”
“No, I dropped them someplace over there by my car”.
“Then why are you looking for them here under the street lamp?”
“Because the light is better here.”
Price fluctuation data on U.S. companies is widely available on the internet for free. But it’s just not where you find the key to proper valuation of investment assets.
My friend, the late Ron Morris (founder of The American Entrepreneur radio show) often told me that when he was considering whether to invest in a start-up, he would look at three things: the business model, the quality of the entrepreneur himself, and the external market. Which one was most important? Hands down, he said, it was the external market.
The most important thing about whether the business will succeed is whether it is in a growing sector in a growing economy. Morons can make money in an environment like that. Even geniuses have trouble making money in a stagnant environment. Yes, some people get rich during stagflation, but by definition those people are rare. JFK was right: a rising tide does lift all boats, even those boats under the command of captains with sub-centennial IQs. Likewise betting your assets entirely on an exercise in finding the best skipper in a fleet all of which is mired in the mud may be an exercise in investment futility.
Mr. Bowyer is the author of "The Free Market Capitalists Survival Guide," published by HarperCollins, and a columnist for Forbes.com.
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