Since March 2009, the S&P 500 has surged by nearly 60% and US Treasuries have continued to surge, pushing yields close to all-time lows. This has elicited sighs of relief from professional investors, who see the strength as sure signs of recovery. Yet, these investors are ignoring - willfully or otherwise -- the very thin trading volume upon which this rally is built. Retail investors remain scarred by the '08 collapse and have steered clear of the stock market altogether. Instead, they have parked cash in the Treasury market (hence the low yields).
Still, financial gurus are flush with tales of deep value that await investors who have the fortitude to wade into the market. This past week, with significant fanfare, Warren Buffett reduced his position in Proctor & Gamble while increasing his holdings of Johnson & Johnson. Perhaps Buffett is growing increasingly distrustful of a consumer revival, but feels that government support will keep health care from feeling the pinch? While parsing the nuance of Buffet's stance, most American investors are missing the big picture.
For want of a better cliché, reallocating US stock positions is like rearranging deck chairs on the Titanic. It would be far wiser to seek passage on a sturdier ship that is sailing with the tide, rather than against it.
When compared with the US markets, the stock markets of Brazil, Russia, India, and China (collectively known as the BRIC economies) have shown far greater returns over the past decade. Over the past five years, the S&P 500 has declined more than 12%. Over the same period, the Shanghai Composite has more than doubled. Brazilian, Indian, and Russian markets have shown lesser, but significant gains. These returns were based on economies with faster growth rates than what we have come to expect in the US. What's more, the growth was primarily achieved not with government subsidies, but with organic market demand fueling legitimately productive enterprise.
The conventional wisdom is that investing in dollar-based equities is "safer" than parking capital abroad, but we have several reasons to believe this is no longer true. Massive government stimulus packages appear to have failed to restore confidence, but have widened the federal government's fiscal gap. States are edging toward bankruptcy, many remaining solvent only because of the market's assumed guarantee of federal backing. The nation's largest banks are entirely dependent on federal support. On top of all this, Congress is now discussing nationalizing the mortgage insurance market, officially transferring tremendous unrealized losses to the taxpayer.
America is effectively bankrupt, but refuses to acknowledge the losses. Instead, they are being assumed by Washington, which is itself hopelessly indebted to foreign governments. This risks an international run on the dollar, which early indications show has already begun.
Meanwhile, the American private sector is exhausted. Anxiety over future stimulus and debt is now combined with fears over tax increases, greater corporate regulation, renewed political strength of organized labor, and new employer health care burdens.
If America is headed for depression, then US equity, real estate and even bond investments may become increasingly risky relative to the BRICs (and resource economies like Australia and Canada).
Still, many may be reluctant to increase their overseas holdings out of lingering concerns about risk. The guarded approach has been to invest in US corporations that generate a high proportion of their earnings from abroad. We see this as a poor substitute for the real thing. While it is true that foreign markets plunged more steeply than the US in 2008, it is also true that their rebound was far more dramatic. For the most part, the BRICs were dragged down in the credit crunch due to their dependence on the dollar-centric monetary order. They learned from this, and are diversifying as rapidly as possible.
As the severity of our troubles becomes clear, US stock markets will experience another major correction (in real terms). Even good companies with overseas earnings will likely be dragged down by the chaos of inflation, protectionism, regulation, and taxation that tend to follow economic upheavals.
Now may be a time when those individual investors still holding US securities and bonds might wish to follow the example of the People's Bank of China and begin harvesting their dollar gains. With the proceeds, investors should allocate to economies showing growth based on genuine demand and solid fundamentals.
