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It may have seemed like an odd time to do it, but recently a guest speaker we hosted told our clients that he and his firm thought “emerging market” countries offered better investment opportunities than domestic stocks for the next 5 years or so (maybe even longer). The timing might have seemed odd because we had been telling our clients for the last couple of months that we thought U.S. stocks (and bonds) were grossly undervalued and that the U.S. economy was slowly rising from the ashes of 2008. You see, we’ve been correct in our assertion that almost any good economic news would be greeted with great relief and probably a rebound in the U.S. stock market. Since early March, we have had better news, it appears that the economy is slowly stabilizing . . . and the major indices are up 30-40% since that time. So why on earth would we sponsor an event where the speaker tells our clients that investors who are predominantly in U.S. stocks may miss the boat? Why? Because it’s a valid – albeit debatable- point. Focusing too much on U.S. stocks in a portfolio can be shortsighted and might hurt long term performance. And even allocating a portion to “developed” foreign markets doesn’t provide the non-correlating boost it once did, as the EAFE Index (Europe, Australia, and Far East) is very highly correlated with our own S &P 500. Historically, they tend to move up and down in tandem. Whereas, the Emerging Markets Index is far less correlated with the S & P 500 than the EAFE. In a Fidelity white paper entitled “International Investing”, they made the case that an optimal equity mix (this is the stock part of your portfolio, only) in terms of risk/return was an approximate mix of 60% U.S. Equities and 40% international. They went on to report that portfolio was further improved by using emerging market equities for part of the international allocation. We hope you’re with us so far. Having everything doing the same things . . . highly correlated . . . is bad for a portfolio, in our mind. Time was when adding a little developed international stocks would fit the bill. It doesn’t any more, because they largely have moved the same way our domestic stocks do. But, using stocks from lesser developed countries (emerging markets) can help, can reduce correlation, and historically would have reduced your risk and increased your return (Morningstar, Fidelity). Of course, we cannot guarantee that this will always be the case. So what is an emerging market country? These are countries that are in the process of rapid growth and industrialization, maybe like we were after WW II. There are 28 of these countries (depending on whose list you use), and examples are China, Brazil, the Philippines, India, and Indonesia. What makes emerging market countries potentially attractive for your portfolio is that over 90% of the world’s population lives in these countries (World Bank). That’s billions of people who are interested in owning phones, refrigerators, cars, and driving on paved streets. These are people – many of whom are just beginning to use real currency for the first time- who want to buy things. China’s population has a national savings rate of almost 25% (the U.S. is now at 5.7%, up from less than 1% for much of the last decade), and their government as well as ours is encouraging Chinese citizens to spend more. Can you imagine a billion people spending an additional 5 to 10% of their income (even at relatively low wages)? Our largest companies have recognized the opportunities overseas for years. Wal-Mart, GE, Proctor and Gamble, Starbucks, and Boeing all derive a large percentage of their income from outside our borders. Even Heinz (catsup and beans!) derives 60% of its sales from overseas. There’s no getting around it, for the equity part of your portfolio, most investors need to have some international flavor, and we say you need to spice it with emerging market exposure. When we become so engrossed with our own politics and the daily, incessant, news flashes it is difficult to tear ourselves away and just take a deep breath and look at the global view, the macro view . . . the long view. There are opportunities elsewhere. Nearly 60% of the global market capitalization is non- U.S.; almost all of the major infrastructure projects (new airports, dams, highways) lie outside our borders; and much of the emerging market banking system was insulated from the most recent financial disasters. They were not exposed to derivatives and excessive debt. And, overseas, many stocks are pretty cheap. They are back to 1997 levels in pricing, but their price/book (price is the market value of all shares; book value is assets minus liabilities) valuation is twice as attractive as it was in 1997 (MSCI All Country Index data). Emerging countries are generally moving toward more deregulation and more privatization which can bode well for investment and growth. After listening to our speaker a week or so ago, a number of clients approached us and asked if they should move a much larger portion of their portfolios into emerging markets. It’s easy to listen to a well-reasoned, convincing argument and be moved to make dramatic moves. We’ve all felt this. The truth is, such things are opinions, as well thought out as they are, even backed by as much data as they are. We don’t really know if “emerging markets” are the next big thing. And we would never encourage you to jump in with all you’ve got anyway. The smart move continues to be to cover all the bases, in fixed income as well as stocks, domestically and abroad. Asset allocation, as boring as it seems, is the key. We will continue to bring ideas to you that will help you capitalize on broad global themes. And by adjusting your portfolios accordingly, our goal is to enhance your returns and reduce risk. This is one of those times. We agree with our speaker that emerging markets (countries like India, China, Brazil, and Mexico, among others) may offer more growth, and that inclusion of an emerging market element in your portfolio may be wise. But we don’t make big bets with your money, and – for the stock and bond portion of your portfolio- we still favor a majority position in domestic investments. For, it is entirely possible that the next big thing lies within our borders, within the great intellectual capital of the U.S. We won’t bet against that. Craig
Pulliam and Michael Comstock are CERTIFIED FINANCIAL
PLANNER™professionals practicing at 112
Westwood Place, Suite 310, Brentwood, TN. They own
Premier Asset Management and are registered
representatives and investment adviser representatives
with/and offer securities and advisory services through
Commonwealth Financial Network:
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