Market sentiment. On a
day-to-day basis, it's impossible to predict what will happen in stock
markets worldwide. One week, the market is up on better-than-expected
economic indicators, and the next it's down because of a new development
in the sovereign debt crisis in Europe. "It's so unpredictable," says
Roger Aliaga-Díaz, senior economist with the investment strategy group
at Vanguard. "That's one of the reasons that we focus more on the long
term."
[See 50 Best Funds for the Everyday Investor.]
Growth expectations. Research
over the years has proven that higher GDP growth doesn't necessarily
translate into higher stock returns in a particular country. The
correlation between the two is actually negative. Take China, for
example. From the beginning of 1993 through the end of 2009, China's GDP
grew at an annualized rate of 11 percent, which ranked it first among
countries represented in the MSCI All-Country World Index (ACWI),
according to a research paper released by Heckman Global Advisors.
During the same time period, the MSCI China Index returned a measly 0.6
percent per year, on average. On the other hand, from the start of 1989
through 2009, the U.S. economy grew at a much slower annualized rate of 5
percent, while the MSCI USA Index returned an annualized 9 percent.
Investors should pay attention to analysts'
expectations for higher or lower economic growth in a given country.
"You want [to invest in] markets where you find GDP growth is
accelerating," says Leila Heckman, senior managing director,
international equity, at Mesirow Financial in New York. "If you knew the
bottom of a recession, that's probably the best time to be investing in
a market." Heckman says she generally advises her clients to avoid the
fastest-growing countries because sometimes that growth can be priced
into the stocks very quickly. Currently, she's telling clients to
underweight China in their portfolios.
[See 6 Risks Every Investor Faces.]
Valuation. In the long term,
valuation plays an important role in driving stock prices in a given
country, says Jay Ritter, a professor of finance at the University of
Florida. Price-to-earnings ratios (P/E ratios) are used to measure the
value of stocks. Trailing P/E ratios track historical earnings, while
measures like forecasted P/E ratios track expected earnings. Both can be
helpful in determining how expensive or cheap a stock (or stock market)
looks. One of the most commonly cited measures of the price of U.S.
stocks is the Shiller P/E ratio, which divides the level of the S&P 500 by the average earnings of the S&P during the last 10 years.
"When this ratio is high, future stock returns will be low. But
anything can happen for a year or two, or even five. When the Shiller
P/E is low, it is a good time to buy stocks," Ritter says.
[See 6 Numbers Every Investor Should Follow.]
Momentum. Despite what's going
on in the economy or with a particular company's fundamentals, investors
will sometimes trade on momentum. "Often investor psychology can pile
on and drive a stock price higher and higher, well above fair value, and
that can happen for an extended period until finally there is a
correction," says Steve Cucchiaro, founder of Windhaven, a Boston-based
investment advisory group. "Conversely, there is a time when stock
prices can be pushed down."
Central bank activity.
Generally, you want to invest in a country in which the central bank is
lowering interest rates. While interest rates remain at virtually zero
in the United States, other rapidly-growing nations are being forced to
raise rates because of inflation concerns. So while it seems that
economic growth would be beneficial for stock prices, too much growth
can actually have a negative effect. "As these economies like China and
Brazil grow faster and faster, they begin to overheat, then inflationary
pressures rise, then the central banks decides that they don't want
inflation to get out of hand, so they start to raise interest rates, and
usually, that's a long process," Cucchiaro says. "That acts to cut into
stock valuations."
