Thursday, December 17, 2009
Subtitle: Investment Strategies for the Age of Global Economic Change
As 2009 comes to a close and we prepare for the unknowns of 2010, it seems a just time to quickly summarize the current status of our global economy.
There is a global shift taking place from the traditional power centers - the U.S. and to a lesser degree Western Europe - towards heavily populated, emerging players. This shift, which would have taken place even without the near collapse of our financial system, is now intertwined with the decisions made to stave off disaster over the last year.
The United States acted as the motor for growth and consumption over the last fifty years. The American consumer has driven this consumption, especially over the last twenty years, through debt. We are all aware this can no longer occur and a shift towards savings and debt repayment means consumption will have to come from elsewhere. This U.S. led consumption has made an enormous impact on other countries as well. By importing more goods than it exported, the U.S. generated a large current account deficit resulting in the sending of vast sums of US dollars to the exporting countries. Oil producing nations have likewise accumulated hundreds of billions of dollars due to the exporting of oil to the U.S. and other rich world countries. Amassed with US dollars these countries through vehicles such as sovereign wealth fund, are seeking a home for their liquid dollar assets - from homes on the French Riviera to large stakes in Morgan Stanley.
As exporting nations have been producing goods for the U.S. at low cost, they have put ever more demand on natural resources (commodities). They have begun to see an upward pressure on wages as their local economies grow. Both of these factors, demand for commodities and increasing wages, will fuel inflation. Add on top of this the government spending in the rich world in the forms of various stimulus plans and inflationary concerns abound even though we are currently in a quasi-deflationary period.
Basic demographics are also changing with Europe's population getting older, the US being in between and countries such as Brazil possessing a rather young population. Governments will have to respond accordingly as they struggle to provide the services these population segments require. Demands for certain goods and services will become more relevant based on these shifts.
The above encapsulation of global economics is the context within which El-Erian, the world's largest bond investor, and former directer of Harvard's Endowment fund, frames this concise and relevant text. The majority of the book is spent setting the stage for what is to come and what has developed over the last few eventful years.
He then attempts to outline measures that can be taken to benefit from these shifts taking place. How as investors can we accumulate the wealth needed to support a prosperous future? And, equally as important, how can we counter balance our portfolios to prevent massive loss through huge downswings in markets or erosion of certain asset classes due to inflationary effects?
I am no longer in possession of the book so I can only recall what stayed with me since I read it over one month ago. This will have certainly been meshed together with my own beliefs. Perhaps this is a more useful exercise. Some points for investing in the future:
1. Develop a view of the global economy and dedicate a certain percentage of assets to the shifts you believe likely to occur. If inflation is a concern due to rising wages in Southeast Asia, commodities, real estate or inflation protected securities will be safer bets than cash or certain types of equities.
2. Watch out for "home bias". Investors have the tendency to buy stocks from their home country, especially in the U.S. but also in other countries as well. Active Swedish investors place 48% of their invested money in Swedish stocks even though Sweden makes up 1% of the global economy (Thaler & Sunstein, 2008). Investing in what you know makes sense up to a certain degree but does not warrant such a disproportional approach. This is equally true in the States where a robust and transparent equity market warrants a large percentage of investment focus but not the absurdly high percentages most Americans have in their home market.
3. Emerging Market Government Bonds can essentially be grouped with more traditional bond types as their government balance sheets are in healthier shape than many more traditional markets, e.g. Greece and Ireland.