Recently, an acquaintance asked for some advice on allocating accumulated assets in his 401(k) account. I suggested that he allocate the entire amount to whichever mutual funds in the company plan were dedicated to investing in international stocks. He reacted with surprise, asking whether my suggestion was too risky. â€œI think it is the safest thing you can do with your equity allocations,â€ I replied.
I am sure, however, that this investor will not take action on my advice. It is just too far removed from what he has always heard or read about investing. Conventional wisdom dictates that an investment portfolio should be heavily allocated in domestic stocks, using â€œcore funds,â€™â€™ as identified by Morningstar or other mutual fund rating groups.
International or emerging markets funds, on the other hand, are used, instead, as â€œsupporting roleâ€™â€™ options. And most who design portfolios would argue that smaller allocations of 15% to 20% would offer wonderful diversifying benefits and exposure to other growth opportunities — without increasing oneâ€™s risk exposure recklessly.
Long ago, I filed such investing wisdom in a folder labeled â€˜â€™Investing Baloney.â€™â€™ Let me explain why.
First, regular readers know that I have recommended in this column for the past three to four years that international funds or stocks should make up the â€œcoreâ€™â€™ of an investorâ€™s portfolios. Rather than investing in the stock market options of only one country, the U.S., investors, by purchasing international stocks and funds, are investing in many other countries. Your options include buying the best of all offerings in Europe, such as in England, France and Germany, and in the Nordic countries like Sweden, Norway, Finland and Denmark. Refer to the performance over the past few years of the Fidelity Nordic Fund and see the returns earned by investors in this quiet corner of the worldâ€™s equity markets.
For those seeking a diversified portfolio of stocks as well as diversification in the economies of several countries, as opposed to just one economy, the U.S., does this recommendation look diversified? Or you might have chosen an even more diverse option such as Fidelityâ€™s Diversified International Fund. (And, you should also check the performance on that one.) In addition to those stocks and markets in Europe, you could have added additional diversification and safety with the inclusion of stocks in Asian economies, as well as a small dollop of Latin American stocks.
Again, how does this look in terms of diversification and safety? Instead of risking the bulk of your savings in one countryâ€™s economy and stock market, you would have included those of many countries, which, in most cases, are benefiting from their leadersâ€™ long-range strategies for managing their economies.
Those economies differ from ours â€“ and the way our leaders manage the domestic economy by printing money massively to finance record-setting trade and Federal budget deficits. A good illustration of this comes from the CIA. And, yes, itâ€™s the very same CIA you think it is.
That organization recently released a neat little table, showing the ranking of the largest 163 countries around the world in terms of their current account surpluses or deficits in 2006. The table measures each nationâ€™s trade surplus or deficit, together with its balance of earnings from investments in assets abroad.
In first place, China in 2006 enjoyed an account surplus of almost $180 billion, followed by Japan with a surplus of nearly $175 billion. Next was Germany with about $135 billion in surplus; then came Saudi Arabia with almost $104 billion and Norway with $63 billion.
At the bottom of the list, in last place, was the U.S., number 163 out of 163 nations included in the survey, with a screaming, ripping, massive current account deficit of $862 billion. Just above the U.S. was Spain with a deficit last year of just under $99 billion.
Letâ€™s step back for a second and ponder which economies are working from a position of strength and which from a position of weakness? Which economies offer better climates for investors? The amount of money flowing out of the U.S. was about equal to the amounts flowing into the eight strongest performers — combined!
To this information, letâ€™s add some data gleaned from the May 25 issue of the Financial Times, a must-read newspaper for all investors. An article entitled â€œThe $2,500 Billion Questionâ€™â€™ reports massive amounts of foreign exchange reserves held by foreign governments and accumulated, in large part, from their current account surpluses. The article points out what those central bankers plan to do with the money, in excess of cash needed to stabilize their own currencies in the event of an emergency.
Many, such as the U.A.E., Singapore, Saudi Arabia, Norway and China have allocated over $2 trillion in combined assets for investment around the world in higher yielding stocks and bonds. Meanwhile, the U.S. needs more than $2 billion in borrowed funds from some of those same countries — every day! While the rest of the world goes shopping with excess discretionary funds, the U.S. searches the world over for money to borrow!
In the worldâ€™s financial markets, Uncle Sam is the guy on the corner of Main Street, holding his hat in hand and looking for a few coins to make it through another day! Where is the position of strength? If you could invest in a broadly diversified basket of stocks, the best from each country, which areas appear safer to you?
From another perspective, taken again from the May 25 Financial Times, consider reports from meetings hosted by our president with Madame Wu Yi, Chinaâ€™s Vice Premier. Mr. Bush reported discussions with his Chinese counterpart on the revaluation of the Yuan, including a request that China open its financial markets to American firms and also open its markets to imports of our beef.
According to the article, Mr. Bush and his deputy, Hank Paulson, expressed disappointment at how little progress they made in each area and â€œthe limited resultsâ€™â€™ gained by our side. Of course, since the Chinese are our largest lenders, effectively making them our bankers, how much strength do we project in suggesting changes for our benefit?
As for revaluing its currency to help alleviate the soaring U.S. trade deficit with China, the Vice Premier simply stated that this wasnâ€™t a problem of its making and revaluing currency was not in Chinaâ€™s best interests. In other words, she said â€œNo!â€
Another article in the paper uses the title â€œBush calls for tougher sanctions on Iran.â€™â€™ Where have we heard this before? The Bush team has been trying to inflict economic pain on Iran for many months, but those sanctions in place â€œhad been too weak to change Tehranâ€™s course.â€™â€™
China and Russia apparently have much to gain by doing business with Iran, especially with the U.S. intimidating its allies who also might want to do business there. And those two countries have had enough power to dilute all U.S. efforts to punish Iran.
In times past, how long could a country like Venezuela have continued to openly defy the U.S. in order to further its own economic and political development? Past history indicates that leaders like Hugo Chavez would have been visited by U.S. representatives from the IMF or World Bank and offered terms of capitulation. And if the talking didnâ€™t work, well, what does the CIA do, anyway, besides compiling data on which countries are the strongest economically?
Add into this mounting data what is happening to U.S. military power, with the war in Iraq sapping its manpower and equipment, which must be replenished at great cost. And the U.S. will need to borrow money for this, too. The funds to borrow will most likely come from China and Saudi Arabia — as long as they agree to lend, that is. And remember that the U.S. is on the cusp of incurring massively increasing costs for Social Security and Medicare obligations.
And yet, many people continue to think that investing internationally is more risky! As readers know, I have loaded up in those international markets to the near total exclusion of domestic stocks for the past few years, which makes my â€œbad callâ€ on the strength of the U.S. bull market cycle feel much less painful. In fact, gains from these stronger markets have more than offset any lost domestic opportunities, as well as capital lost from shorting or hedging efforts where I have consistently bet against domestic markets.
I believe that all that excess cash held by foreign central bankers will find homes in healthier economies around the world, which will help power those markets higher in coming years. As for domestic markets, all bets are off when bankers in China, Japan and Saudi Arabia turn off our credit spigot. Our economy is in their hands as much as it is in ours. The only offsetting tool at our disposal, should they decline to lend us money, is to print even more of it than we do now. No wonder inflation is soaring!
Now, are your perceptions unchanged regarding who is dealing from strength–and who is not?
Have a great week.
Bob Wood ChFC, CLU Yusuf Kadiwala. Registered Investment Advisors, KMA, Inc., firstname.lastname@example.org.