Over the past three years, stock markets almost everywhere have provided incredible returns. For example I work with Denmark ’s second largest bank. They are global equity experts and one of the portfolios (the Green Environment Portfolio) we created together rose 266.3% in one year. Another (The Emerging Market Portfolio) rose 114.2% in 2006 and 122.6% in 2007.
Yet in each case these portfolios also encountered gut wretching drops on their way up. That Green Portfolio for example in July 2007 dropped 103.22% in one month. The Emerging Market portfolio also moved like a yo-yo (see below).
In fact, over the last three years, despite impressive gains, there have been two periods of global market panic when almost every stock market dropped….like a stone….only to recover like a rocket ship
Now we are seeing a third such global wave of dumping shares.
This begs several questions. “Is this the big one?” “Will markets again recover…and when?”
An even more important question is “How can we as investors know what’s coming with at least a semblance of accuracy?”
The answers to these questions are important because if a recovery comes, history suggests it will be sudden and dramatic. Xxxxxxxx
You can see the recovery potential in the performance of the portfolios we created and tracked last year from November 2006 to October 2007. Equity markets collapsed in a month but recovered even faster. The portfolios utterly collapsed from July 20 to August 17. Then they rose between 40% and 128% in just two weeks.
| Portfolios 2007 | July 20 | Aug 17 | Aug 31 | Oct 31 |
| Swiss Samba | 45.84% | 15.19% | 26.42% | 53.32% |
| Emerging Market | 67.67% | 30.50% | 58.18% | 122.62% |
| Dollar Short | 40.31% | 9.14% | 20.29% | 48.19% |
| Dollar Neutral | 38.07% | 13.56% | 22.33% | 38.67% |
| Green | 214.15% | 110.93% | 155.84% | 266.30% |
If the recent stock market dive is just another short term correction, some investors will make fortunes.
Here is a simple idea that can help you become a good global investor, a whiz at international investing. The idea is that three simple facts can help you spot distortions in equity markets.
The first fact was confirmed by Alan Greenspan in his excellent book, “Age of Turbulence”.
“A major aspect of human nature-the level of human intelligence-has a great deal to do with how successful we are in gaining the sustenance for survival. As I point out at the end of this book, in economies with cutting-edge technologies, people, on average, seem unable to increase their output per hour at better than 3% percent a year over a protracted period. That is apparently the maximum rate at which human innovation can move standards of living forward. We are apparently not smarter to do better.”
That’s a huge fact. Overall we should expect the global economy to grow at about 3%.
This gives us a baseline for how much an investment should grow.
If an economy rises faster than 3%, it is distorted. During early stages of excessive growth, investors will be attracted. Shares will rise faster.
If the economy remains robust, shares become overbought. Then watch out! A correction will come.
This leads us to the next fact which is “all investments have risk”.
Rather than wasting time trying to avoid risk…which cannot be done, investors should look at three risk elements instead.
#1: How much risk is there in any particular investment?
#2: What perceptions doe the market have of the risk?
#3: What risk premium is due?
Bank accounts and government bonds, for example, are perceived as the safest investments (especially if government guaranteed). A look at their long term history shows that they pay about 3%. So if a bank account or government bond pays less…in the long term it’s bad. If it pays more…that’s better. Yet the idea is that bank accounts will not really make money. They will just keep up with growth…at 3%.
To get real growth requires taking risk. If an investment appears to be less safe it will pay more than 3%. This is called a risk premium.
Bonds pay more than bank accounts because they are perceived to be less safe. Stocks pay more than bonds because they are perceived even riskier. Emerging market stocks pay more than major market stocks. Emerging market bonds pay more than major markets bonds.
Over the long run, bonds issued in countries and currencies perceived to be stable pay 5% to 7%.
Stocks in major countries should pay 7% to 10% annual return in the stock market as a function of global growth, long term earnings growth plus risk premium (above bank accounts and bonds).
To attain higher growth than 7 to 10% investors must either increase risk, trust luck or spot distortions.
This is good because the market is almost always wrong. Most investors always trying to avoid risk. Most investors dump their wealth into investments that are perceived to be safe. This creates excessive demand and lowers value and actually makes the perception wrong.
Knowing this helps wise investors spot trends created by distortions.
Take, for example, the emerging market trend that has been created by an imbalance in labor costs around the world.
There are 6.6 billion people on this earth (give or take a few hundred million). 1 billion of these people live on a dollar a day. 2.5 billion live on two dollars a day. This means that there is a vast pool of cheap labor that can create goods at bargain prices. Mature economies are buying these goods at such an increased rate that 20% of all goods produced now cross a border, mostly from poor countries to the rich.
This means that emerging economies are growing much faster than 3%. They are catching up and this has caused major markets to slow down.
The global economy grew 5% last year…way ahead of 3%. Mature economies are growing only 2.3% each year on average….so there is a lot more growth in emerging economies. Thus emerging stock markets are growing faster than matured stock markets as well.
Yet emerging economies are perceived to have greater risk.
Smart investors have seen the value create by this distortion and have been cleaning up. They have been paid a huge risk premium when the risk has not been real!
The risk has been eliminated by low labor costs in poor countries and improvements in communications and transportation.
In 2007, emerging stock markets had their fifth consecutive year with double-digit returns. The Morgan Stanley Capital Index (MSCI) Emerging Markets benchmark, gained 39.4 % in US dollars compared to 9% for the MSCI World Index of the developed markets in 2007.
This was the seventh calendar year in a row in which emerging markets have outperformed the developed markets. In this time, the MSCI Emerging Markets index delivered a total return of 341 % in US dollars while the Major Markets Index gained 45.8 %.
Finally we come to the third fact. Periods of high performance are followed by times of poor performance.
Emerging stock markets have outgrown major markets by about 7.5 times in the last seven years. Yet their economies are only growing about twice as fast.
Major markets have grown on average about 6.5% per annum for the past seven years….a little below what they should.
This means that it is probably time for emerging equity markets around the world to correct down and major markets up a bit.
Yet in times of global panic as we have recently seen, all markets tend to drop. This means that at this time major markets which may have been somewhat undervalued and should be rising are being pushed down by the drop of emerging markets (which should correct themselves).
Understanding these three facts leads us to know that a portfolio of global shares is the most likely bargain at this time.
We can see this fact in a recent comparison of two portfolios we have created with Jyske Bank. One, the Blue Chip Portfolio invests in shares of blue chip companies headquartered in six countries and denominated in five currencies, Swedish kroner, Euro, Swiss franc, yen and US dollars.
This is a safe portfolio that statistically should be rising. Yet the Blue Chip has fallen more than the Emerging Market Portfolio which invests in equities in China , India , Eastern Europe and other emerging countries (a portfolio that according to statistics based on the 3% solution should correct).
| Portfolios 2008 | Nov 16 | Dec 14 | Jan 21 2008 |
| Emerging Market | -13.33% | - 9.80% | -36.78% |
| Blue Chip | - 2.78% | - 5.14% | -37.68% |
There you have it. Understanding the 3% solution and what markets have done shows a distortion. Blue chips may be oversold more than emerging shares now.
In the long term, emerging shares will rise. Poor people remain and are willing and able to make goods that the rich will buy. This will push their economies higher faster than in major economies. Yet for now the three percent solution shows that major markets and high quality shares are more likely to recover from the current doldrums first.
Global investing has proven itself to be more profitable. Why not? Modern communications and transport coupled with a vast pool of low cost labor almost guarantees this fact. Now knowing three more facts based on the 3% solution can give you an edge when it come to taking advantage of the ups and downs in this global trend.
Gary
Join us this winter or spring at one of our tours and courses are below:
Feb. 18-23 Ecuador Import Export Course
See all types of products to export. Here is some Ecuador Jewelry.
Mar. 7-9 International Investing and Business Made EZ Ecuador
Enjoy our courtyard companionship at our hotel as we talk about economies and markets during meals and at breaks.
Mar. 10-11 Imbabura Real Estate tour
See Ecuador ’s wonderful architecture.
Mar. 12-14 Coastal Real Estate tour
Enjoy Palmazul Spa where we will stay during the coastal tour. Here is a room there.
Mar. 7-9 IBEZ and Mar 10-11 Imbabura Real Estate tour
Mar. 7-9 IBEZ and both real estate tour
Most delegates in March will join us for two or three courses as there is a sizable savings.
If you attend all three courses separately the fees are $1,847. Sign up for all three at only $1,499 here. Save $348. Three course savings.
Three courses for two separately are $2,597. Two on our three course adventure is only $1,999. Save $598. Three courses savings for two.
April 10 – 14 Super Thinking + Spanish
