One of the recurring themes in my daily column is that money has to go somewhere. Large financial institutions and funds must generate a return on their holdings, if for no other reason than to justify their managers’ salaries. In simpler times that truism would lead investors to make adjustments in the ratio of stocks to bonds in their portfolio. If things looked bad, increase the amount of bonds and when the economy was booming, load up on stocks…simple really.
We now live in an era of globalization. Capital shifts readily between regions and countries. Successful investors understand this, and the existence of ETFs that track each country and region has made shifting your own capital based on regional expectations easy and cheap. Despite that, there is still a home country bias in most countries investing habits. Home bias is decreasing, but in 2010, here in the US, investors still had over 70% of their money invested at home, though the US accounted for only 43% of global GDP.
This is understandable; the economy and markets of one’s home country are better understood and easier to follow for one thing, but at times it can lead to problems for those who like to make adjustments in their portfolios. Right now in the US, it leaves many investors looking for the lesser of two evils.
The government is, as I write, still closed. Congress appears, if anything, more dysfunctional than ever. We are approaching another fight, this time around the debt ceiling. If all of these things are resolved quickly, then it is likely that the Federal Reserve will see the way clear to reduce monetary stimulus, or QE, and the market will react negatively to that. The problem here is that the traditional flight to safety, buying US Treasuries, doesn’t look attractive either.
If the debt ceiling is not increased, the full faith and credit of the US will be called into question. I know that the last time that happened, Treasury prices actually increased in the ensuing debacle, but, if it happens again, there is a good chance that big money won’t be as forgiving. What was considered an aberration may look like becoming a habit. If the crisis is averted, the Fed’s anticipated tapering will reduce the amount of bonds they purchase, putting downward pressure on bond prices. For domestic investors, it would seem there is nowhere to hide. I am not trying to be sensationalist or a merchant of doom here, but I know many feel this way and are looking for something to hedge their fears.
One answer may be to buy the old standby…gold. The problem there, however is that the yellow metal has been caught in its own dynamic, falling from an overbought position and looking stuck around $1300/oz. There is also the fact that, from a fund manager’s perspective, the only return gold offers is from price appreciation; it pays no dividend or interest.
Europe, while recovering somewhat, still has potential problems from high debt and unemployment in peripheral nations and, to some extent, is sensitive to problems in the US. Emerging market growth is slowing. Japanese equities have recovered nicely, but have begun to drop from their peak in May.
The problem is that as goes America, so goes the world. If you believe that the end of 2013 will be tough for investors, where do you hide?
For some, the answer may be on the other side of the World, in Australia. Australia is not immune to problems in the US or global economy. Indeed, during the recession of 2008/2009 their stock market was hit hard.
As you can see, the iShares MSCI Australian ETF (EWA) fell from a high of 34.83 in October 2007 to a low of 10.50 in March of 2009. This time around, should the worst case scenario unfold, I believe it will be different. The effects of Government policy and action (or inaction), unlike a credit crisis, are reversible. The downturn in the US, should it come, will likely be more contained than in 2008. If we somehow muddle through, and the Fed does begin tapering, then the resulting reduced supply of US dollars could well put upward pressure on commodity prices; a positive for Australia.
From the bond perspective, 10 year yields on Aussie Government bonds of around 4% give a return on money parked there to ride out the storm. There is, of course, a currency risk, but if chaos reigns in the US, it is unlikely that the Dollar will appreciate significantly against anything. Conventional wisdom is that, because of the slowdown in China, Australia could be facing lean times. This could be true, but I am not suggesting long term investment, just a place to send some money while the US is the focus of bad news.
I am not by nature a pessimist. While I can see a correction in US stocks, and possibly bonds as well, as usual long term investors are best served by riding out any turbulence. As I have said before, however, sometimes this is easier if you do something when you are worried. Adding some Australian equities or bonds to your portfolio may give you a chance of seeing some appreciation, or at least slower depreciation, if things look scary. This sense that you took the right action helps to avoid panicking out at the bottom and makes it easier to stay the course.
Home bias in investing is common and understandable, but when both domestic stocks and bonds could come under pressure, sending some of your money on a vacation, far away from the trouble, may help.