One of the effects of EU convergence has been a convergence of the stock markets of eastern and western Europe. CEE stock markets are approaching their western peers in terms of correlation, according to Helmut Pfeffer, stocks analyst at Raiffeissen Zentralbank (RZB) in Vienna.
Three CEE stock markets – the Hungarian BUX, the Czech PX50 and the Polish WIG20 – have shown a convergence in both the correlation levels of the stock indices and valuation levels of the stocks within these indices.
A comparison of the MSCI forward P/Es of the three candidate countries and the MSCI EMU P/Es show that the differences between have been small since the beginning of 2001, he says.
Western and eastern European stock indices have also become more correlated. The chart above shows that the periods of very low correlation – in the case of the PX50 almost negative – ended with the Russian crisis in 1998. Since then correlation levels have been relatively high. Only in the second half of 2000, after the worst of the crisis had subsided, did correlations fall.
Pfeffer says this is bad news for portfolio managers who need to diversify. “Rising correlation does not bode well for the argument of investing in CEE markets from a pure portfolio management point of view . But it definitely indicates ‘convergence’ in the sense of CEE stock markets linking up with their western peers. It indicates ‘mature’ CEE markets”
Pfeffer also tested whether the recent good performance of CEE stock indices has been driven by EU entry prospects by plotting bond yields against stock indices.
He started with the assumption that the positive news of the EU entry negotiations is directly influencing the currency and bond markets. To see whether stock markets follow political news in the same way , he did a regression analysis of index returns against the so-called ‘spread tightening’.
The results were inconclusive, with a low correlation between BUX and PX50 returns and the decline in the relevant bond yields. The only noteworthy (negative) correlation was for the WIG 20.
Pfeffer concludes that the Hungarian and Czech stock markets performed well more so for company-specific factors than because of approaching EU entry. However should EU entry talks bog down, CEE stock markets would certainly be affected.

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