Go for the globe

By Dean DiSpalatro | December 1, 2011 | Last updated on December 1, 2011
8 min read

There’s no shortage of experts encouraging investors to build more globally oriented portfolios.

But the investment environment abroad can be highly precarious, depending on whose backyard you’ve wandered into. A sound understanding of economic and political drivers, as well as key underlying trends like demographics is critical to formulating a safe and profitable global investment strategy.

Four experts walk us through some of the issues investors need to take into account when looking to the U.S., the Eurozone, China, and South Asia.

Craig Basinger,

Private Wealth Strategist, Macquarie Private Wealth

Dan Hallett,

Vice President and Director, Asset Management, HighView Financial Group

Michael Hasenstab,

Senior Vice President, Portfolio Manager, and Co-Director, International Bond Department, Franklin Advisers, Inc.

Gareth Watson,

Vice-President, Investment Management & Research, Richardson GMP

U.S.?

Basinger It’s unfortunate how the debt ceiling issue was handled. The impact of the temporary impasse sapped more investor and consumer confidence out of the market and the economy. [Yet] there’s a lineup to buy Treasuries—there’s no actual liquidity problem. That’s one of the benefits of having the reserve currency.

One of the bigger problems is [aging populations] in a lot of developed nations, including the U.S., are going to have a material impact on government finances for the next 10-to-20 years.

The only way to address this is to claw back some of the benefits people have become accustomed to receiving. The U.S. is starting to look at this even when there’s no shortage of money. There’s nothing forcing them to look at this, [except] they see entitlement spending getting out of control.

Watson The Republicans will do everything they can to make the president look bad on the jobs front before next November. But something has to be done before the next election. The market, of course, is telling us that whatever they come up with will likely not be effective.

If the U.S. continues to struggle, it’s going to show up in Canadian numbers. We’re already seeing some signs of that. I remember seeing research reports in 2006 and 2007 on how we were supposedly decoupling from the U.S. You had to throw those reports in the garbage once the crisis hit in 2008, because it showed that economically, we are still extremely dependent on the United States. Hallett The U.S. has overcome more dire economic circumstances with even higher rates of unemployment. The political process can seem to get in the way of the solutions, but I have faith in their political leaders and that they’ll resolve to do what’s needed to get the country back on track.

Eurozone

Watson Earlier this year, the perception was that the Europeans weren’t worried enough about the situation. Events of the past month have shown they now seem to get it. They understand their economic malaise is impacting the rest of the world, and the rest of the world wants them to fix the problem.

In Europe the entitlement mindset is so embedded that any rollback is bound to cause a riot. What’s needed is a social change that restructures people’s expectations in line with what’s attainable. The status quo entitlement regime is unsustainable because of demographic realities.

Basinger The Eurozone crisis is both a liquidity and a structural problem.The structural problem has existed for some time, and every once in a while it flares up as a liquidity problem. You have the same currency and monetary policy, but you have very different fiscal policies, and rules within each of these nations that cause friction.

Germany, for example, has a massive stake in keeping the Eurozone intact. If the euro unwinds, the Deutschmark goes through the roof, and all of a sudden their exports grind to a halt.

The sovereign debt issue won’t go away. [Countries] can provide liquidity stopgaps that get them through temporary spikes, but they’re just pushing the issue forward. Addressing the out-of control entitlements would go a long way towards dealing with the problem.

Hallett Greece had been digging a fiscal hole for so long. I’m doubtful of their ability to orchestrate an orderly default. It’s certainly not going to be pretty, no matter how orderly it might be. If you’re taking a 50% write-down on this debt, there’s going to be some ripple effects. A lot of European banks are knee-deep in this mess, so they’re going to get hurt. The origina mistake was letting Greece into the EU, because these debt problems are nothing new. Greece has spent half its existence defaulting and restructuring its debt.

Hasenstab The recent market panic gave us a unique opportunity to invest in Ireland, which we view as a special case. We thought the double-digit yields over the summer did not reflect the underlying strength of the Irish economy, which was the second-fastest growing economy in Europe in the second quarter of this year. This growth was driven by a trade surplus running in excess of 20% of GDP.

Ireland, unlike many of the troubled Eurozone economies, is externally competitive. This is partially due to the internal devaluation Ireland has managed with a reduction in unit labour costs of over 20%, but also due to durable competitive advantages that existed before the crisis: a highly educated workforce and a business-friendly regulatory and tax regime.

Middle East

Watson When it comes to investors, the Middle East isn’t significant at this exact moment. Obviously there has to be concern about Saudi Arabia, which is part of the G20 and certainly influential with oil. So investors look at the region more from an energy perspective than from an overall investment perspective. Down the road there may be opportunities for investment in that part of the world, but there is an inherent risk investors have to be aware of.

Basinger Egypt is the biggest of all the Arab Spring countries, and even its piece of the emerging markets landscape is a small sliver. So from a strictly investment point of view, the Arab Spring is not a terribly material development. But if the flow of oil was disrupted, there would be a quick response, because the world needs its 82 million barrels a day.

Hallett From an investment standpoint, the uprisings in the Middle East don’t change the way I manage money. Politically, I think they’re a positive development overall, but it will be a bumpy road ahead. You can’t live in a certain culture for so long and then just flip a switch. Old attitudes will linger with certain segments of the population, so the democratically oriented protesters may not get the change they want.

Pakistan and India

Watson Pakistan worries me. It’s politically unstable and they’re a nuclear country.

Basinger It’s much easier to get exposure to these areas indirectly, rather than by actually buying stocks in Pakistan and India. There are a lot of companies in the U.S. and Canada where a big portion of their business is driven by demand and economic growth in those parts of the world. Most Canadian investors will have a much higher comfort level investing in a $250-million Canadian company than in a $3-billion emerging market company.

U.S.- China

Watson From an economic perspective, the biggest issue is U.S.-China relations. The Americans are continually frustrated that the Chinese are not letting the yuan float enough. It makes you wonder how protectionist the U.S. will get.

There are some concerns about China [due to] the lower-than expected GDP numbers for Q3. But they have a number of tools at their disposal to fight off economic turmoil. There is also a social component that people tend to forget: a lot of their economic decisions are made to avoid the kind of uprisings we’ve seen in the Middle East. I don’t see a Chinese equivalent because the government will take the necessary steps to control inflation and keep people employed.

Basinger China needs the U.S. much more than the U.S. needs China. It would be bad for U.S. Treasuries if China unloaded them, but it would be disastrous for China if the U.S. stopped importing from China.

Hallett There’s a lot of talk about China being the biggest lender to the U.S., but that’s because the U.S. is the largest consumer of Chinese goods. Even though the U.S. is on its knees fiscally, and China seems to be an unstoppable economic power, China will run into its own problems at some point. You can’t subsidize industries forever without negative consequences.

GLOBAL OVERVIEW

Many emerging markets, and select developed ones that were not overly reliant on leverage before the financial crisis, have experienced robust recoveries.

“These recoveries have contrasted sharply with the anemic rebounds observed in the G-3 (the U.S., Eurozone and Japan),” says Michael Hasenstab, Senior Vice President, Portfolio Manager, and Co-Director, International Bond Department, Franklin Advisers, Inc. “As a result, policy responses throughout the world have differed significantly, ranging from unprecedented monetary easing in the G-3 to gradual tightening of fiscal and monetary policy in countries from China and Australia to Sweden and Peru.”

While the recent wave of uncertainty emanating from the Eurozone has caused many policymakers to pause, he says he expects the multi-speed recovery will continue and require continued tightening of policies in many emerging markets.

Still, great care is needed when taking global exposure. Global bond indexes concentrate exposure on the most heavily indebted countries. “In 2000, the largest emerging market country in the Emerging Market Index was Argentina. Today, the largest weightings in the Global Bond Index are the U.S., Japan, and the Eurozone,” Hasenstab adds. “Investors should diversify away from their home countries, but do so in a calculated manner.”

He notes strong relative fundamentals support select currencies and credits and even some duration exposures in economies where the extent of likely monetary tightening has already been priced in; and long-term government bond yields are likely to benefit from improved policymaking and lower-risk premiums over the medium term.

“We have found several opportunities internationally to buy short duration assets that offer relatively high yields in countries with high credit quality,” he says. “These positions, such as Australia and Korea, offer the opportunity to pursue relatively high yields without taking much duration or credit risk.”

Dean DiSpalatro is Senior Editor of Advisor Group.

Dean DiSpalatro