New Global Investing – Part 1


As American investors, there are two current large trends that we need to be mindful of when constructing portfolios.  These trends have shaped the last 10 years and will dominate the foreseeable future; the first is the western debt problem.  The second is the great emergence and creation of wealth taking place outside the west in places like Brazil, China, India, Turkey and even the Middle East.

Long Bear Markets and Volatility

In December of 1989, Japan’s equity benchmark, the Nikkei, hit 38,000.  In 1999 it traded around 19,000 and 10 years further along, in 2009 the Nikki traded at 10,500.  Today it trades for about 8,600.  This is a stunning 20+ year bear market in one of the most developed and advanced economies of the world.  This is a country that was and still is a leader in high-end manufacturing, robotics, and labor productivity.  Many articles over this 22 year time frame have called for a bottom in the Nikki only to watch it head lower.  Japan had its own bubble but demographics are the real driver behind the soon to be generational equity bear market.

Here in the US, we have had our own lost decade (and more) in the equity markets.   The S&P 500 was around 1500 in early 2000 only to trade 12 years later around 1250.  More recently, this summer in Germany, their Major Stock index the Dax was down over 30% in a span of 6 weeks.

This extreme volatility is due to the above mentioned western debt problems and the eventual great deleveraging that is starting to happen.  In the US, this can be an orderly process as the US dollar is still the preferred reserve currency and the US treasury market is the deepest and most liquid market in the world.  This has been validated by US bond yields dropping and in some cases going negative in times of crisis as people, institutions and governments seek the safety and liquidity that only US Treasury bond can offer.  This liquidity will be defended by the current Fed Chairman through aggressive easing that could take a variety of forms.  But all of which end up in the eventual printing of more money.  The real question is how long can this continue?  And can it be bullish for US equities?

In Europe, we are seeing a disorderly deleveraging process.  Individual, economically weak countries are being targeted, their bonds are being sold and lending costs jump dramatically.  Hence the extreme stock market swings in Germany.  Greek bond holders were asked to “voluntarily” accept a 50% haircut.  Now Italy is being targeted.  Italy is the 11th largest economy in the world with a GDP of about $1.8 trillion yet carries the world’s third largest debt burden.  Greece by contrast has a GDP of about $315 billion.  While the 50% reduction in the value in Greek debt hurt European banks, an Italian default would essentially kill the euro as we know it.

What to do? An American Investor Perspective

Benefits of Country and Currency Diversification

The US is still truly an innovative country and we will continue to lead the world in technology and the entrepreneurial spirit.  However, we don’t have a corner on this market and much of the growth in stock market capitalization over the next 20 years will be created outside of the US.  In the past year, we have seen a shift in the allocation of target dated funds even by conservative companies like Schwab and Vanguard.  In early 2010, Arbor Capital completed an analysis of several of the industry leading target-dated funds.  A comparison of these funds at the time resulted in the following findings:

Ratio of US to Foreign Stocks by Target Date Funds - January 2010

22 months later, we see a shift:

Ratio of US to Foreign Stocks by Target Date Funds - October 2011

(a number closer to 1 means a 1:1 ratio of US/Foreign Stocks)

Schwab’s ratio of US stocks to foreign stocks didn’t change much but Fidelity and Vanguard made changes to their overall allocation.  Vanguard issued a press release discussing this in October of 2010.  While this is not groundbreaking, it is noteworthy that major managers are increasing their foreign stock allocations even from an index-like approach.

Coming next month:  Part 2 – Emerging Market Allocations

About Matthew Kolesky

Matthew Kolesky is a Principal at ACM, Inc. and joined the firm in 2004. Matthew Kolesky was born and raised in Alaska and has served on many Anchorage area non-profit boards.