When someone asks, “is the stock market up?”, the usual reply isn’t “which one?” We tend to assume that markets move together, and if one is up then the others probably are too, but that isn’t always true. This year, returns have varied greatly among different countries. In the past, differences have fallen along regional lines or into broader categories such as emerging vs. developed or large vs. small countries. But so far in 2020, region or size can’t fully explain the dispersion in returns. 1 1 Close Talking about size of country here not size of companies. Who would write about that? For example, if we jump to Asia, we see that the South Korean and Taiwanese benchmarks are nearly up double digits, while Singapore and Thailand are down more than 20% each. 2 2 Close As of 10/15/2020. , 3 3 Close The first letter of each country also doesn’t tell much about returns either. I really wish it did.
It’s not surprising that in a chaotic year the differences in the economic, political and social reactions to the pandemic would affect asset prices. The news has been dominated by COVID, so the first thing an investor might look for in a country would be a well-coordinated response to the disease. If economies have been hurt by individual and collective actions taken to prevent the spread of the coronavirus, then a successful containment strategy should mean better prospects for economic growth and domestic asset prices.
Health policy isn’t enough because the economic damage can persist after folks are willing to come out of their houses. The economic response to the crisis is almost as important as the health response. Aggressive fiscal and monetary programs are likely to benefit equities. Rate cuts and asset purchase programs can boost stock prices. Now that rates are zero or negative in many countries, market participants look at fiscal stimulus as a positive catalyst. This favors countries which have been spending on recovery programs and perhaps puts the ones which were on solid fiscal footing prior to the pandemic at an advantage. 4 4 Close It also favors those that have an easy time raising capital, either from high domestic savings or the ability to attract outside financing. Perception of the fiscal position may matter more than any metrics that measure it.
The pandemic affected countries unevenly, and the relative economic performance isn’t entirely about policy. Countries which are heavily dependent on tourism have been hit very hard, while some industries have done well. An economy that specialized in the manufacturing of hand sanitizing ingredients would probably outperform a resort island regardless of the quality of economic stewardship. Market volatility also affected some countries more than others. For example, the drop in oil prices severely hurt energy exporters.
With those characteristics in mind, it makes sense that the South Korean and Taiwanese benchmarks have been near the top of the world. Both countries have been effective in preventing the spread of COVID and have been able to return to some degree of economic normalcy. 5 5 Close Over the last week, reported new coronavirus cases per million people averaged 1.5 in South Korea and less than 0.1 in Taiwan. This compares to new case rates around 150 per million people in the U.S. and Europe. Financial Times: “Coronavirus tracked: see how your country compares,” 10/15/2020. According to consensus forecasts, South Korea’s economy will contract by 1% in 2020 while Taiwan’s is expected to grow by the same amount. 6 6 Close Bloomberg consensus forecasts as of 10/15/2020. For reference, the global economy is expected to contract by 3.9%. Both are oil importers and consumers of foreign natural resources. Both have relatively low public debt levels and ample room for fiscal expansion along with accommodative central banks. Neither were overly reliant on tourism.
The story seems almost perfect. You get the best of the both worlds with those indexes. Sadly, the macro explanation, while convincing, is incomplete. Sometimes even the most macro of us must begrudgingly admit the importance of micro. 7 7 Close This is the cry in my beer moment of the Wrap-Up. In this case, it’s performance within countries which leads us in that direction. In South Korea, the KOSPI is up around 7%, while the more technology heavy KOSDAQ is up over 26%. 8 8 Close Local currency returns from Bloomberg as of 10/15/2020. KOSPI is the Korea Stock Exchange KOSPI Index, and KOSDAQ is the Korea Securities Dealers Association KOSDAQ Index. We see this pattern in countries throughout the world. The tech-heavy indexes are on fire, outperforming their staid counterparts by wide margins. The same is true when looking at which country indexes have been doing well. The Taiwan Stock Exchange Weighted index has a heavy weighting in semiconductors. In fact, a single semiconductor stock makes up 30% of its market cap. That may be a large part of why it is outperforming. 9 9 Close It is probably true that the weightings of technology stocks in indexes do reflect something about the composition of the underlying economies, but they can be overrepresented.
While technology has been less affected by COVID than many other sectors, the rise in their share prices has been driven by expectations of future earnings as much as by their current results. Multiples on those stocks reflect investor preferences rather than economic performance. 10 10 Close Investor preferences are a quant’s least favorite two words. Perhaps these preferences are influenced by their short-term performance, and investors are making exaggerated extrapolations.
This means international investors need to be more aware of the composition of the markets. A shift in regional allocation may be more of a shift in sector allocation than they realize. It may be adding to bets which already exist in their portfolios. Political and economic factors are moving markets, but they aren’t always the primary driver of returns. Paradoxically, the differences in returns among indexes around the world in the past few months have been driven by the same exposures as domestic portfolios. So maybe this year we should call it “local macro.”
What We Are Watching
China GDP, Industrial Production, Retail Sales (Monday)
A new round of high-profile Chinese data will be released on Monday amid what has so far been a notably faster-than-anticipated recovery in economic activity in the country. With successful virus-containment measures implemented earlier than other large economies, China seems to have paved the way for a faster recovery in domestic activity. At the same time, China’s manufacturing sector has been well-positioned for the rebound in global goods demand seen over the last few months. Next week’s data covering third quarter GDP and various activity indicators for September will provide an update on the current state of the Chinese recovery. Positive data may support commodity markets as well as the currencies and equity markets of China’s largest trading partners.
Eurozone PMIs (Friday)
Over the course of the summer, a second wave of coronavirus cases across much of Europe prompted renewed caution on the part of governments, businesses, and individuals. While manufacturing data has continued to show recovery, PMI data suggests that normalization in the service sector may have stalled out. Unfortunately, cases have risen even higher over the last few weeks, prompting several countries and localities to reimpose restrictions on higher-risk activities. PMI data for October will indicate the extent to which these new measures are putting additional downward pressure on service sector activity. A weaker result might prompt increased speculation around the need for easier monetary policy, potentially weighing on the euro and boosting domestic fixed income.
Chile Referendum (Sunday the 25th)
A Constitutional Referendum, called in response to violent and widespread protests in Chile last year, will take place next Sunday. Proponents of a new constitution hope to address the issues that prompted the demonstrations, particularly inequality, access to public services, pensions, and other economic policies. Chile has generally been perceived as one of the most stable countries in Latin America for a long time, but repeated and disruptive protests in recent months as well as potentially profound changes to its institutional framework under a new constitution have dampened this perception. Next Sunday’s vote will be the first national referendum in 31 years. Citizens will be asked whether they want a new constitution and what type of assembly should be responsible for producing it. Polls largely suggest that a new constitution will be drafted. If so, a period of heightened uncertainty could ensue in subsequent months, potentially weighing on Chilean assets.