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Globalization has increased linkages between stock market exchanges. For example, you can trade BHP Billiton (NYSE:BHP) on the New York Stock Exchange (NYSE), the Australian Stock Exchange (ASX), the London Stock Exchange (LSE), and the Johannesburg Stock Exchange (JSE). (This is in reference to the combined entities of BHP)

BHP is a Dual Listed Company (Compliments of Stockcharts.com)

With all the cross-pollination of countries within exchanges, is the country of origin still relevant? Do stock specific fundamental ratios and global sector performance matter most and make country selection pointless?

America's Love / Hate Relationship With Domestic Stocks

On December 12th, 2010, The New York Times reported that for the 4th year in a row, more money has been withdrawn from domestic mutual funds then has been added. One could conclude that interest is waning in domestic investments and that globalization is becoming firmly rooted into investors. Although this shows some shift, what do the overwhelming numbers show?

Earlier, on July 27th, 2010, Forbes magazine reported that the average American holds between 75 – 90% of his stock portfolio domestically, even though the US represents less than 50% of the global market (by capitalization, not total number of listed stocks). While markets are interconnecting, allowing for global investments, it would seem that investors are reluctant to pour money into foreign investments regardless of how easy an exchange makes foreign purchases.

It seems that Americans love their domestic stocks, although this may be somewhat waning of late.

Globally Interconnected Markets: Are Sectors More Important Than Country Selection?

But I am dodging the issue: Does it matter what country you invest with, or is sector choice all that matters?

  1. If globalization has efficiently linked markets together, then sector investing should be the most important regardless of which country it is. If sector is king and country of origin doesn't matter, then you truly do not need to diversify between countries since all are equal. Alternatively, you could scan for fundamentally strong stocks in all countries without any concern as to country effect since there is none.
  2. On the other hand, despite globalization, if certain countries perform better than others regardless of global sector ratings and stock fundamentals, then being judicious on country selection would still be important.

David J. Garff, from Accuvest Global Advisors wrote the paper, Global Equity Investing: Do Countries Still Matter? The paper came out February 2011 and hit on some very interesting points.

  • Countries are becoming more strongly correlated with each other although it appears cyclical in nature
  • Peru and Indonesia have been in the top 10 performing country markets 7 and 8 times during the past decade.
  • Although sector effects have increased over time, country effects have a debatable higher importance as to performance.
  • The 10 largest stocks in each country were more highly correlated to their country market than any global sector.

Where does that leave us? The country effect is alive and strong, although there is still an argument as to which effect is strongest. Globalization has aligned markets of late, but there are still vast differences between countries. (Just look at how volatile Chinese small caps are). Regardless, if we want to remove the country effect, or play on its volatility, we should acknowledge and account for its presence.

Lessening the Country Effect

For those wanting to diversify to remove country and sector specific volatility from their portfolio, having a range of sectors and countries should create a neutralized holding. Instead of arguing whether sectors create more risk and volatility than country effects, neutralize both. How can this be achieved?

Buy stocks across a variety of sectors and countries with a focus on fundamentals. Thus, if one country outperforms the other, your portfolio should have one holding offset the other. On the other hand, if country correlations continue to strengthen, your holdings will be no different than fully domestic portfolios. You are protected either way. (You might also like to read on a sector-weighting strategy here.)

Or, you might prefer to invest in some of the largest stocks from many countries to have a correlation to many diverse countries. This allows you to pick and choose among the biggest stocks for the best momentum and fundamentals.

Here are the top non-US stocks listed on the NYSE.

No.

Ticker

Company

Sector

Country

Market Cap (mil)

1

BHP

BHP Billiton Ltd.

Basic Materials

Australia

261275.47

2

PBR

Petroleo Brasileiro

Basic Materials

Brazil

259572.74

3

PTR

PetroChina Co. Ltd.

Basic Materials

China

245742.3

4

BBL

BHP Billiton plc

Basic Materials

United Kingdom

219077.62

5

HBC

HSBC Holdings plc

Financial

United Kingdom

202577.16

6

CHL

China Mobile Limited

Technology

Hong Kong

188468.07

7

VALE

Vale S.A.

Basic Materials

Brazil

180260.2

8

BP

BP plc

Basic Materials

United Kingdom

150655.93

9

VOD

Vodafone Group plc

Technology

United Kingdom

149210.02

10

TM

Toyota Motor Corp.

Consumer Goods

Japan

143863.08

11

TOT

Total SA

Basic Materials

France

141636.3

12

RIO

Rio Tinto Plc

Basic Materials

United Kingdom

136339.11

13

NVS

Novartis AG

Healthcare

Switzerland

126500.4

14

SI

Siemens AG

Technology

Germany

118900.85

15

TEF

Telefonica, S.A.

Technology

Spain

114602.04

16

LFC

China Life Insurance Co. Ltd.

Financial

China

105804.01

17

STD

Banco Santander, S.A.

Financial

Spain

103562.24

18

CEO

CNOOC Ltd.

Basic Materials

Hong Kong

101510.3

19

ITUB

Ita

Financial

Brazil

100789.22

20

FMX

Fomento Econ

Consumer Goods

Mexico

99921.79

21

GSK

GlaxoSmithKline plc

Healthcare

United Kingdom

99407.41

22

E

Eni SpA

Basic Materials

Italy

96969.76

23

AMX

America Movil S.A.B. de C.V.

Technology

Mexico

90782.61

24

UN

Unilever NV

Consumer Goods

Netherlands

90545.34

25

UL

Unilever plc

Consumer Goods

United Kingdom

88896.33

26

BUD

Anheuser-Busch InBev

Consumer Goods

Belgium

88605.94

27

SNP

China Petroleum & Chemical Corp.

Basic Materials

China

87908.17

28

CHA

China Telecom Corp. Ltd.

Technology

China

85654.88

29

NVO

Novo Nordisk A/S

Healthcare

Denmark

84611.74

30

EC

Ecopetrol SA

Basic Materials

Colombia

84506.79

Or, you may prefer to diversify by holding country specific ETFs:

Ticker

Name

ECH

iShares MSCI Chile Investable Market Index Fund

EGPT

Market Vectors Egypt Index ETF

EIS

iShares MSCI Israel Capped Index Fund

EPU

iShares MSCI All Peru Capped Index Fund

EWA

iShares MSCI Australia Index Fund

EWC

iShares MSCI Canada Index Fund

EWD

iShares MSCI Sweden Index Fund

EWG

iShares MSCI Germany Index Fund

EWH

iShares MSCI Hong Kong Index Fund

EWI

iShares MSCI Italy Index Fund

EWJ

iShares MSCI Japan Index Fund

EWK

iShares MSCI Belgium Investable Market Index Fund

EWL

iShares MSCI Switzerland Index Fund

EWM

iShares MSCI Malaysia Index Fund

EWO

iShares MSCI Austria Investable Market Index Fund

EWP

iShares MSCI Spain Index Fund

EWQ

iShares MSCI France Index Fund

EWS

iShares MSCI Singapore Index Fund

EWT

iShares MSCI Taiwan Index Fund

EWU

iShares MSCI United Kingdom Index Fund

EWW

iShares MSCI Mexico Investable Market Index Fund

EWY

iShares MSCI South Korea Index Fund

EWZ

iShares MSCI Brazil Index Fund

EZA

iShares MSCI South Africa Index Fund

FXI

iShares FTSE/Xinhua China 25 Index Fund

INP

iPath MSCI India Index ETN

PLND

Market Vectors Poland ETF

RSX

Market Vectors - Russia ETF

SPY

SPDR S&P 500 ETF Trust USA)

THD

iShares MSCI Thailand Index Fund

TUR

iShares MSCI Turkey Index Fund

VNM

Market Vectors Vietnam ETF

Trading Country-Specific Momentum

That being said, there are those who prefer momentum investing. You can track the different country specific ETFs above and see which have the highest monthly returns (or whatever momentum period you use from 3 months to 12 months).

Ticker

Performance (Month)

EWC

6.21%

EGPT

4.86%

EWA

3.71%

THD

3.05%

The idea behind momentum is that past winners will make future winners, and copious research supports this. (Read more in this article on 30 Explosive Stock Picks Based on Fundamentals and Momentum). Some of the countries will allow for some sector diversification such as China, but other countries have meager ETF sector options in this regard.

If you are really keen and want sector plus country momentum, then first find out which sector is performing best, and then which country is performing best, and filter for these two variables with your scan.

As an example, with the EWC Canada Index Fund leading the one month momentum, and energy being a top pseudo-sector, I add this to my screen with a couple other personal filters for future EPS growth and high performance over the past month to come up with these stocks:

Ticker

Company

Industry

Country

BTE

Baytex Energy Trust

Independent Oil & Gas

Canada

CVE

Cenovus Energy Inc.

Oil & Gas Drilling & Exploration

Canada

CNQ

Canadian Natural Resources Limited

Independent Oil & Gas

Canada

NOA

North American Energy Partners Inc.

Oil & Gas Equipment & Services

Canada

So regardless of how you play this, globalization, which appears to have increased correlation between nations, still has not done away with varied performance of individual countries.

Whether you choose to mute this effect by having a globally diversified portfolio or play up the advantages by country and sector momentum, you should be aware of the potentially cyclical effect of varied country performance.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Source: Using Globalization to Your Portfolio's Advantage