How to Select a 'Correlation Strategy' for Picking Companies

How do macroeconomic trends translate into specific stock selections for a mutual fund?

S&P Capital IQ has published a paper that outlines a new method for analyzing how macroeconomic figures can lead to microeconomic results. That is to say, choices of what companies to put in a mutual fund’s holdings.

The method, outlined in the paper titled “The Potential Effect of U.S. Macroeconomic Factors on Company Fundamentals,” involves looking at key macroeconomic factors and tying them to microeconomic results.

The approach starts with factors such as the supply of money, trade balances, unemployment and gross domestic product. Then, it looks at the sectors that have the highest correlation, or are most directly affected, by those factors. Then, it applies them to companies within the sector or sectors of interest.

In this way, fund managers can drill down from macro-economic indicators and find sectors, industries or even companies to look out for.

“I can keep my calendar out for when major economic figures come out, like the GDP, and then by finding the sectors that have the highest correlation to this number. I can find out what’s worth watching,” said Thomas Yankel, one of the writers of the report.

The paper demonstrated this method using the macroeconomic factor “manufacturing capacity utilization” that leads to a focus on the Warren, Ohio-based auto electronics manufacturer Stoneridge Inc.

The logic, roughly, goes along these lines:

The U.S. auto components sector stands out because it is highly correlated, both negatively and positively, with U.S. macroeconomic prospects.

Manufacturing capacity utilization, on average, has been the most positively correlated macroeconomic factor with the U.S. auto components industry. Economic expansion drives up manufacturing capacity utilization -- and auto components suppliers benefit. Economic contraction hurts just as fast, because consumers quickly put off major capital purchases.

In that light, Stoneridge Inc., a supplier of electronic components for the medium- and heavy-duty truck, automotive, agricultural, and off-highway vehicle markets, stands out among companies in the auto components industry

Stoneridge Inc.'s total sales are the most positively correlated with manufacturing capacity utilization within the industry, and one to watch when the economy is changing sharply.

While past performance is no guarantee of future results, over the 10 years between December 2001 and December 2011, Stoneridge Inc.'s total sales have closely tracked U.S. manufacturing capacity utilization.

In the U.S. economic downturn of 2007 to 2009, a steep contraction in the economy coincided with a significant drop in total sales for Stoneridge.

The paper attributed this correlation, among other factors, to Stoneridge's large U.S. industrial customer base, consisting of Navistar International Corp., Deere & Co., Ford Motor Co., General Motors Co., and Chrysler Group. Those firms made up roughly 55% of Stoneridge's total sales.

Tommy Fernandez writes for Money Management Executive.

 

 

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