November 29, 2004 Copyright © 2004, Greenwich Financial Management Inc., a registered investment advisor. Securities offered exclusively through Purshe Kaplan Sterling Investments of Albany, NY, a NASD member firm.
YOUR WEALTH
Investing in International Equities--Where, When, How
Table of Contents
1. Comparing Market Opportunities
4. Japan
6. Conclusion
1. Comparing Market Opportunities
There is substantial evidence to suggest that the US dollar is in a long-term decline pattern, domestic interest rates are headed higher, and some resurgence of domestic inflation is probable. (See our recent series of articles on the federal deficit and the national debt at www.GreenwichFinancial.com .) In light of these problems, it may be prudent to consider investing a portion of ones portfolio overseas, in non-dollar markets. Some international diversification always makes sense, but a more pronounced effort may be particularly timely now. We will take up this theme, with a focus on international equity markets.
Just as individual stocks can be valued in terms of the ratio of the price per share to earnings per share (the so-called "P/E ratio"), so can markets as a whole. In the accompanying table, the expected P/E ratios for a number of the more active international market indices are given in the fourth column (all data from 11/30/2004).
All things being equal, a low P/E investment is more attractive than a high P/E. But, just as with individual stocks, all things are not equal! Different markets enjoy different overall rates of growth of earnings. The composition of stock indices differs as to the industries predominating in them and the potential of these industries to grow. Average company capitalization will vary across markets and indices, as will leverage. The currency exchange relationship with the reference currency (we use the US Dollar as reference here) may change. The definition of accounting "earnings" differs from market to market. Important aspects of corporate governance and the rule of law will vary. And the degree of fluctuation in price levels ("volatility") will differ sharply across markets and time.
As shown in the accompanying chart ("Expected Return of International Stock Indices"), our first step in creating a framework for comparison is to estimate nominal stock index rates of return--including dividends but excluding the effects of changes in foreign exchange rate. As a second step, we estimate future change in the value of each relevant currency in relation to the US Dollar. As a third step, we adjust our prediction of nominal stock index rates of return by taking currency into account. In the right-hand columns, we show expected annualized rate of return, ranked from highest to lowest, adjusted for currency changes, and expected total return for the next five years, also adjusted for currency changes.
In predicting foreign exchange rate and stock index movements, we draw on detailed macro-economic data forecasts from the experts at Oxford Economic Forecasting (a subscription service; see www.OEF.com for details; UK-based, but not related to Oxford University). An alternative approach would be to take earnings estimates from a "bottom up" service, such as IBES, which aggregates predictions of earnings on individual stocks to create a market index forecast. I believe the bottom up approach has a bias toward bullishness, whereas the Oxford service is aided by an awareness of macroeconomic limits and bottlenecks. I follow the Oxford forecasted numbers strictly here, for the sake of consistency, even where I might disagree. For example, I believe the Chinese currencies, the Renminbi and the Hong Kong Dollar, both now
EXPECTED RETURNS OF INTERNATIONAL STOCK INDICES
Country |
Price/earnings ratio of major stock index (times) (2004 est.) 1 |
Stock Index Projected Total Return, Including Dividends 2 |
FX total projected rate of $ return, 2005-2010 (per annum) |
Expected real rate of index return, 2005-2010, per annum |
Expected next five years total real return (annual compounding) |
Hong Kong |
17.580 |
140.08% |
0.00% |
19.14% |
140.08% |
Thailand |
10.624 |
136.21% |
3.27% |
18.88% |
137.43% |
Brazil |
10.942 |
125.62% |
-19.89% |
17.02% |
119.42% |
Korea , Rep. |
11.415 |
110.57% |
-4.61% |
15.91% |
109.24% |
China |
39.397 |
105.06% |
3.29% |
15.55% |
105.95% |
Indonesia |
12.559 |
114.43% |
-32.49% |
15.52% |
105.73% |
Russia |
6.344 |
114.31% |
-35.36% |
15.44% |
105.01% |
Italy |
17.866 |
107.32% |
-22.11% |
15.04% |
101.48% |
Malaysia |
15.165 |
101.32% |
0.00% |
15.02% |
101.32% |
Singapore |
13.776 |
98.87% |
0.36% |
14.75% |
98.96% |
USA |
17.499 |
96.28% |
-0.00% |
14.44% |
96.28% |
Netherlands |
11.926 |
100.56% |
-22.11% |
14.31% |
95.15% |
Taiwan |
12.827 |
81.34% |
6.38% |
12.81% |
82.66% |
Japan |
31.606 |
74.49% |
6.49% |
11.93% |
75.70% |
Germany |
15.064 |
76.40% |
-22.11% |
11.52% |
72.46% |
UK |
18.711 |
67.49% |
14.45% |
11.19% |
69.97% |
France |
14.518 |
70.62% |
-22.11% |
10.80% |
67.02% |
Mexico |
13.889 |
64.91% |
-10.73% |
10.30% |
63.29% |
Canada |
16.727 |
62.59% |
-15.26% |
9.91% |
60.41% |
South Africa |
11.602 |
55.39% |
-26.50% |
8.75% |
52.12% |
Spain |
15.043 |
54.30% |
-22.11% |
8.68% |
51.63% |
Portugal |
19.700 |
46.95% |
-22.11% |
7.67% |
44.67% |
Switzerland |
15.717 |
4.68% |
-21.38% |
0.88% |
4.49% |
1 - The source of the P/E ratios is the exchanges sponsoring the tradable indices. This analysis assumes that the dividend yield currently being paid on each index will continue unchanged during the period 2005-2010 (adjusted for splits and other anomalies) and the total dividends paid out (if any). Total return in any year = index return plus dividend return. Index return equals (Index Year 1-Year 0) (/Index Year 0). |
|||||
2 - The source for forecasts of exchange and stock index performance is Oxford Economic Forecasting. For consistency, we have adhered to the OEF forecasts strictly, though I disagree significantly with a few. In particular, I believe that the US Dollar is in the midst of a multi-year secular decline versus a number of other currencies such as the Yen, the Pound and the Euro. I also foresee that China will be forced to abandon its currency peg against the dollar, leading to a sudden sharp revaluation at some point within the next two to three years. The OEF FX forecasts are consistent with these views in direction but not extent. Some data is derived by extrapolation from these forecasts. Any mistakes are my own. |
|||||
pegged to the US Dollar, will revalue sharply against the Dollar in the course of the next couple of years, but I have hewed to OEF's more status quo forecast.
As you can see, there is a wide dispersion in expected real rates of return among our sample of countries. The Asian "Tigers" rank very high, including China/Hong Kong, Thailand, South Korea, Indonesia, Malaysia and Singapore. I am advising clients to hold a diversified portfolio of Tiger equity risk to take part in the growth of this regional economic colossus. Russia, which has turned in a stunning bull market performance in recent years, following its debt default debacle in 1998, still appears to be attractive. Brazil has a lot of upside, Mexico less so. In my view, Japan's rate of return will be augmented by further revaluation of its currency. According to our total return model, the U.S. market, as measured by the S&P 500 Index, has significant upside in the next five years, although it will be outpaced by much faster growing emerging markets. Stodgy Switzerland has a poor outlook.
Of course, the integrity of the forecasts is crucial. As the old saying goes, "garbage in, garbage out." Nevertheless, a thoughtful "top down" approach such as outlined here is a useful starting point for any investigation of international investment opportunities.
(November 30, 2004)
We have begun by ranking a number of stock market indices in order of their likely performance over the next five years. According to our analysis, if you want to outperform in the next five years in international equities, focus your bets especially on the Asian Tiger group, Brazil and Russia. The ranking, however, did not take into account how violently those indices (and underlying markets) swing around, called "volatility." Let us now reconsider those results and grapple with how to make adjustments according to volatility. This gets only a little technical-and it's really important to understand--so stay with me!
Many factors may affect your attitude as an investor toward volatility. One is your horizon of investment-how long you intend to stay in (and related to this, your age and health status); the longer your staying power, or the more remote your need to cash in, the less you need to worry about short-term fluctuations. A second factor is your ability, if any, to hedge the risk. A third is your surplus funds available outside of the money at risk. Finally, there is a subjective factor: call it, your degree of gaming spirit.
Volatility is usually measured in terms of "standard deviation" over some interval. Some definitions: "variance" is the summation of the squared differences between each data point in a series and the mean (average) data point, this quantity then divided by n, the number of data points. "Standard deviation" is simply the square root of variance. Roughly speaking, standard deviation gives you an idea of how widely data scatters around its average level. In a normal, (bell-shaped) curve, about 95% of the data sampled will fall within two standard deviations greater than or less than the mean.
In 1966, Professor William Sharpe proposed a "reward-to-variability" ratio that we now call simply the Sharpe Ratio (Sharpe received the Nobel Prize in economics in 1990). The Sharpe Ratio is easy to compute. Let's assume we're looking at annual periods. You need three numbers: the rate of return on your investment, the "risk-free rate," and the annual volatility of your investment. US Treasury Bills are taken as a surrogate for the ideal-type of a risk-free security. To find "excess return" over the benchmark, subtract the risk-free rate from the rate of return on your investment. To find the Sharpe Ratio, simply divided excess return by the volatility, measured as one standard deviation. The higher the ratio, the more return you are getting per unit of risk. In this exercise, as our horizon is five years, let's take the yield on the US Treasury 5 Year Note, which is currently 3.57%, as the benchmark, rather than using the shorter Treasury Bills. In the accompanying chart, you will see that the Hong Kong Heng Seng Index has the highest expected rate of annual return over the next five years. But the Russian Micex Index has the highest Sharpe ratio.
I like to look at all investments in terms of expected annualized rate of return. The Sharpe Ratio doesn't preserve that desirable format. Also, the Sharpe ratio doesn't adjust for individual ability and willingness to take risk. So I've developed an approach, illustrated in the rightward three columns, based on the premise that we can determine for any given investor a degree of risk propensity. Positive numbers indicate risk aversion. Negative numbers equal risk attraction. To find the risk adjusted return, take the expected annual return and subtract from it the quantity equal to volatility times the investor's risk propensity constant. Using the risk propensities of 0.1 and 0.2, Hong Kong remains on top. But for the risk prone investor with a negative 0.2 risk propensity, Thailand scores higher, owing to its greater volatility.
One of the key goals of an investment advisor at a first serious client meeting is to gauge the investor's risk propensity. The advisor may note that equities have outperformed bonds over almost all long periods of US financial history. But equities tend to have greater volatility than bonds. Could you stomach a 15% loss of value of your portfolio in a bear market? How about 25%? The answers to these questions help to guide the advisor toward appropriate investment and asset allocation suggestions. The investor's risk propensity constant may be estimated by finding the point of indifference of a client investor among different investment scenarios: for example, if the investor feels about the same to make 10% per year, with 20% volatility, or 12% per year with 30% volatility, then the investor's risk constant would be 0.2. [Solve the equation 10% - (20% * R) = 12% - (30% * R), where R= risk propensity.]
A conclusion from these numbers: even after adjusting for volatility, emerging stock markets such as China/Hong Kong, Thailand, Brazil, Korea, Indonesia and Russia look attractive. As an investment advisor, I am overweighting those markets for clients who are familiar with and can accept emerging markets risk.
(December 24, 2004)
We have brought together evidence that over the next five years, stocks of selected emerging markets should outperform the US market and those of other developed countries. Of the emerging markets, we highlighted the so-called "Asian Tigers"--including China/Hong Kong, Thailand, South Korea, Indonesia, Malaysia and Singapore-as well as Brazil and Russia. Let us now consider how to invest in these equity markets in a blended fashion; it will not focus on particular stocks. We will also touch on India, which was not included in our earlier analysis, but which has a great deal of growth potential.
Please keep in mind that emerging markets tend to fluctuate more widely than developed markets. However, if you can take a long-term view with a portion of your money, if you can stomach the volatility, and if you enter and exit at a good point in the cycle, there can be really substantial rewards.
If you would like to have exposure to emerging markets throughout the world, a good choice might be Oppenheimer Developing Markets A (stock symbol is "ODMAX"). It is an open-end mutual fund. Open-end mutual funds are bought and sold at their net asset value (NAV), unlike closed-end funds, which are traded in stock markets and may trade at a substantial premium or discount to their NAV. The fund had a management change in 2004 but continues to follow its policy of investing in stocks offering growth at a reasonable price (known for short as "GARP"). It has outperformed its benchmarks for one year, two years and five years. There is a 5.75% front-end sales load (which can be waived if purchased through one of the mutual fund "supermarkets"); the annual management expenses are 1.52% currently. The fund has about $2.5 billion in assets. It is rated five stars by Morningstar (its highest rating; see www.morningstar.com ), an authoritative source of information and evaluation of mutual funds.
For overall exposure to the Asian Tigers, an excellent open-end mutual fund is Matthews Asian Tiger Fund ("MAPTX"). The fund's senior managers are Mark Headley and Paul Matthews, experienced managers who focus exclusively on Asia; they have strong internal research support. Its annualized expense ratio is 1.48% per annum, which is not high for this category. There is no sales load upfront, but there is a redemption fee for short-term holders, which the fund initiated to inhibit "market timing." The fund has about $764MM in assets. It is rated four stars by Morningstar. 2004 total return was 23.3% (as of 11/4); 2003 total return was 60.2%; 2002 return was -6.5%. You might also consider the Templeton Dragon Fund (TDF), a closed-end fund managed by the legendary Mark Mobius. Annual expenses run at 1.64%. The fund is currently trading at an attractive 7% discount to its net asset value (NAV). It is rated five stars by Morningstar.
For a specific emphasis on China, you may want to consider the Matthews China Fund (MCHFX). Its managers are Headley, Matthews and Richard Gao. This fund is also no-load and open-end, with an annual management fee of 1.5%. The fund has about $388 MM in assets. The firm invests in all classes of Chinese shares, including the "B" shares traded only on the mainland exchanges. Volatility is high. It is rated four stars by Morningstar.
A pure play on Korea is the closed-end Korea Fund (KF), traded on the New York Stock Exchange. It is trading at about a 6% discount to NAV. Management is by Scudder Kemper Investments, a subsidiary of Deutsche Investment Management Americas. It is rated three stars by Morningstar.
A pure play on India is Morgan Stanley's closed-end India Fund ("IFN"), rated three stars by Morningstar. It trades on the New York Stock Exchange. Currently, it trades at a surplus cost ("premium") of about 3.5% versus its net asset value. The fund has been managed by Punita Kumar-Sinha since 1997.
The Turkish Fund ("TKF"), a closed-end fund advised by Morgan Stanley Investment Management, currently trades at a 28.73% premium to net asset value, which is very unattractive. Turkey continues to seek full membership in the European Union, and accession talks will begin this year.
For investment in Latin America as a region, consider the open-end mutual fund T. Rowe Price Latin America ("PRLAX"). It follows a GARP investment policy. The portfolio manager is Gonzalo Pangaro. Total assets are $273 MM. There is no front-end sales load; annual expenses run 1.41%. 2004 total return was 38.4%; 2003 return was 57.9% and 2002 return was -18.1%. The fund is rated five stars by Morningstar.
For a pure Brazil play, consider the Brazil Fund ("BZF"), a closed-end fund traded on the New York Stock Exchange. The annual expense ratio is 1.56%. It is rated three stars by Morningstar. The fund's advisor is Scudder Kemper Investments. It is currently trading in the market at about a 7% discount to its net asset value, which is attractive.
Whenever considering a mutual fund investment, be sure to ask your broker or investment advisor for a copy of the offering circular and update (if any). Concerning closed-end funds, it is normally safer not to buy these as new issues, as they will tend to trade at a discount to net asset value after the underwriters stop supporting the initial offering, which would result in a loss to you versus your purchase price. As noted, I advise clients to buy these closed-end funds opportunistically, when they trade at a discount to NAV.
There are also numerous hedge funds that invest in emerging markets equities as well as debt. In some cases, these are "long only" funds (which belies the original meaning of "hedge fund," namely, that it hedges against downturns), as it is difficult or impossible to go short (make a bet against) individual equities in most emerging stock markets. Some focus on only one country, such as Russia. Many hedge funds are leveraged (geared up by borrowing), which increases volatility and the potential for larger gains and losses. Most hedge funds charge not only an annual management fee (usually 1-2%) but also a "carried interest" or "incentive fee," usually 20% of the profit since the previous highest level from which a performance cut was taken, called "the high water mark." Information on such private funds is available by private placement memoranda available only to qualified buyers (based on institutional status, wealth and/or income, under federal regulations).
(December 31, 2004)
Among highly developed markets that may perform well in the next five years, one promising candidate is Japan. Indeed, I believe our initial ranking underestimates Japan's potential performance, particularly on a currency adjusted basis. Japan has been stymied for many years by issues stemming from its bubble economy in the 1980's. One of the most serious problems was the large amount of bad debt on the books of its commercial banks, particularly in real estate lending. Japan's Finance Ministry attempted to resolve these problems incrementally, for example by encouraging stronger banks to absorb weaker ones, which dragged the process out for many years. However, there are many signs that real reform has taken hold and Japan is emerging from this period of stagnation. Japanese stock market indices hit a twenty-year low in the first half of 2003 and have rallied since that time, though leveling off for much of 2004. Deflation has subsided as a risk. The Yen has by and large been strengthening versus the US dollar since 2003 as well, although the dollar has been gaining some strength in the past week as foreign exchange traders anticipate that the US Fed will raise rates faster than other central banks. Unlike other false starts in Japan, I believe Japan's recent recovery can continue.
There
are a number of ways to get invested in Japanese stocks as a pure play: open-end
mutual funds, closed-end funds, exchange traded funds (ETF's) and individual
stocks (through American Depository Receipts, or "ADR's," which trade on
US exchanges in dollar denominations).
You may
want to consider iShares MSCI Japan Index, an ETF. Its stock ticker
symbol is "EWK"; it trades on the American Stock Exchange. The manager
of the fund is Morgan Stanley, which originated and maintains this index. Annual
management expenses are only 59 bp. (For more information on the pros
and cons of ETF's, see http://www.greenwichfinancial.com/wm25.htm .)
To focus on smaller capitalization companies, consider Fidelity Japan Smaller Companies (FJSCX), an open-end fund rated four stars by Morningstar (the highest rating is five stars). The manager is Kenichi Mizushita. The fund has about $1.3 billion in assets. There is no front-end sales load; expenses run 1.59% per annum. Total return was 22.3% for 2004, 60.9% for 2003, 0.9% for 2002, and -20.1% for 2001. The fund's returns since inception in 1995 significantly exceed those of its category. Fidelity's Japan Fund (FJPNX) is rated three stars by Morningstar. This fund focuses on mid-cap and large-cap companies. The fund has about $716 MM in assets. Total expenses run about 1.03%, and this fund is also no-load. Total return was 10.9% for 2004, 37.0% for 2003, -7.4% for 2002, and -33.8% for 2001; the fund has tracked it benchmark very closely but has not outperformed it. [Note: my firm clears and custodies securities through an affiliate of Fidelity Investments.]
Another all-Japan offering is Scudder Japanese Equity, Class A (FJEAX). The Fund's advisor is Deutsche Asset Management, which acquired Scudder Kemper. This fund is rated three stars by Morningstar. Assets of the fund are only about $97 MM. Total returns have been 10.0% for 2004, 38% for 2003, -8.6% for 2002, and -24.6% for 2001. The expense ratio is 1.4%. The front-end load of 5.75% can be waived if purchased through one of the large fund supermarkets.
A young (10/31/2003 inception) but very promising open-end mutual fund deserves special mention: SPARX Japan Fund. Between its Investor (for individual investors) and Institutional class, this U.S. registered fund has about $12 MM in assets, though I expect it to grow apace. The Fund has behind it the research resources of a large organization that manages over $7 billion in assets, primarily in hedge funds, all focused on Japan. I attended an investor presentation by the SPARX founder, Mr. Shuhei Abe, who is a rather iconoclastic figure in Japanese finance He is frequently contrarian and does not shrink from activism in corporate affairs (although SPARX acts only on a basis friendly to management). SPARX follows a multi-cap style, investing in large, mid-size and small capitalization companies. Portfolio managers for the Fund are Mr. Abe and Ms.Kahori Ando. The fund's Investor Class performance was 36.31% for 2004 and has been 35.52% since inception-see http://www.4sunstone.com/sparx/nav.asp . According to Barron's Online , this performance makes SPARX the "best Japan Fund for 2004" (cited on 1/10/2004). SPARX Fund is distributed presently through the fund supermarkets at Schwab and TD Waterhouse or directly from the distributor, UMB Distribution Services.
(January 7, 2005)
Disturbingly, the US trade deficit hit a record $60.3 billion in November. This was a 7.7% increase versus the previous record, made the month before, of $56 billion. The deficits with Canada, South Korea, and Russia all set records in November. The trade deficit with Japan rose to $7.3 billion, while the deficit with the European Union rose to $25.3 billion. The deficit with China, the largest, registered $16.6 billion. Even agriculture is now a net import item in the US balance of trade. It was expected that the recent weakness of the US dollar versus other currencies, especially including the Euro and the Yen, would depress imports and spur exports. This effect is not yet strong enough to offset the growing trade deficit. Moreover, oil prices eased in November, but this did not seem to help much either.
The Associated Press (1/13/2005) quoted Joel Naroff, a consultant for a US forecasting firm, as saying about the November trade numbers, "We now have the Grand Canyon of trade deficits. Actually, deficit is really a misnomer. Chasm, gorge, black hole, infinitely deep well--all fit the description better."
In our piece, "Dollar Crisis in the Making" (written 10/22/2004), http://www.greenwichfinancial.com/wm44.htm ), we suggested that the triple problems of the US budget deficit, the US balance of trade deficit, and low domestic private savings, augur a prolonged period of dollar weakness. At that time, each dollar was equal to 107.46 Yen and 0.793 Euros. As of this writing (1/17/2005), each dollar now equals only 101.86 Yen (a 5.2% decline) and 0.763 Euros (a 3.8% decline). I foresee that the dollar will now find some support. The main reason is that our economy is strengthening, and the Fed has raised rates five times since December 14 th , 2003, each time by ¼% increments; the current target for Fed Funds is 2.25%. During this past week the Fed's bank president in St. Louis said that the Fed is considering dropping its rhetoric of a "measured pace" of tightening, with the intention of accelerating the pace of rate increases. Meanwhile, the European Union sits on its hands, and short-term rates in Japan effectively remain at zero. Canada, the UK, New Zealand and Australia have increased rates during the period of US tightening, but none as much as we have. As US short-term rates increase relative to that of other currencies, the cost of carrying US dollars is decreasing, and the relative cost of financing those other currencies is increasing. I believe this interest rate trend will shore up the dollar temporarily versus the Yen and the Euro, maybe for the next four to six months, after which the secular trend toward dollar weakness will resume.
It is
sobering that a Japanese auto-maker such as Toyota can continue to gain market
share in the US in the face of Yen strength, even while Toyota's cash and
financing incentives are generally less than those doled out by Detroit. This
demonstrates in part the greater ability of Toyota to meet consumer demands
for reliable and fuel-efficient vehicles. It also reflects the ability
of the Japanese to move production to Chinese or US facilities to benefit
from more favorable production factors (in the Chinese case, labor costs,
in the US case, exchange rates and avoidance of protectionist measures). Notably,
Toyota leads in fuel-efficient hybrid gasoline-electric power technology.
Politicians
have frequently raised the specter of foreign competition in recent years.
As a third party candidate in the 1992 presidential election, Ross Perot
spoke of the giant "sucking sound" that would be heard as US firms moved
jobs down to Mexican maquiladora facilities to benefit from the NAFTA Treaty. Ironically,
Mexican industrial workers now face pressures from Chinese competition every
bit as severe as those faced by US industrial workers. There is mounting
evidence that "middle countries," such as those in Latin America, will suffer
disproportionately (or benefit less) from globalization. A country
such as Mexico lacks labor as cheap as that of China, but it also lacks the
high technology, trained labor force, and stable political and legal institutions
of developed countries such as the United States or the UK. Within
advanced societies, the middle classes will similarly suffer pressure, particularly
those workers who have benefited from trade unionism in the past. (See
some of the evidence presented in Geoffrey Garrett's "Globalization's Missing
Middle," Foreign Affairs , Nov-Dec 2004, pp. 84-96.)
For the United States, there can be no successful retreat into protectionism. There have been and will be such pressures, however. What remains in the US of such basic industries as textiles (spinning, weaving, sewing), shoemaking, steelmaking, metal stamping, plastic extrusion, and other basic mass industrial processes, will probably be obliterated in the next few years. The international market in labor is a reality. Trade unionism will suffer further crushing blows, except perhaps in government employment. What remains of our industrial base will be either high tech or specialized. We will have to excel where we can find a competitive advantage in the global economy: in processes that have high knowledge content, that require large capital investment, or that call on advanced skills. And even in these areas, countries such as China and India will give us a run for our money. The competition will be strategic as well as economic; in fact, the current operation of the US in Iraq-with its attendant financial and political costs--may come to be viewed as the beginning of the end of American unipolar hegemony.
While multinational corporations based in the US can take advantage of cheap labor overseas by outsourcing, what will become of our people? This series has focused on the opportunities for financial investment overseas, but what kind of investments should we making in ourselves? To the extent we have ambitious aspirations for our children, they clearly will need all the education they can get, particularly in math, computer technology, engineering, and pure and applied sciences. Those who have only a high school education, or less, will still have opportunities in the economy, through formation of small businesses, but they may no longer be able to achieve a middle class lifestyle as employees. In the job market, they will face relentless competition, both from immigrants working (legally or illegally) in the domestic labor force and from overseas pools of labor. In this light, it is unclear to me that we are we doing enough to ramp up primary and secondary education in this country or to expand scholarships and support for our undergraduate and graduate programs in science and engineering. I also favor measures to increase domestic savings and investment, including, potentially, replacement of the income tax by a value-added tax. I further believe that immigration law should be revised to be country-neutral but targeted aggressively to immigrants with economically needed skills and/or high levels of education.
(January 16, 2005)
Diversification into non-US equities always makes sense for equity investors who wish to diminish their dependence on returns in a single stock market. However, at this juncture, it appears that such diversification is particularly timely.
Within the set of major non-US equity markets, we expect that there will be some winners as well as some duds over the next five years, the horizon of this discussion. Therefore, we do not recommend a single "international" fund or index. Rather, we recommend regional and in some cases single country strategies. We particularly favor the Asian region, especially including China/Hong Kong. In Latin America, we believe that Brazil will be a good performer. Finally, among the OECD countries, we think that Japan will be a strong performer.
We have discussed several ways to get invested, including open-end mutual funds, closed-end funds and ETF's. There is also the possibility of buying a basket of ADR's of individual stocks, though such a basket is beyond the limits of this discussion.
To what
extent will the United States be able to compete in the coming years with
such rising economic powers as China, India and Brazil, as well as with the
European Union, Japan, and the other Asian Tigers? A great deal will
depend on our ability to keep an edge in science and technology, which in
turn will depend on the success of our educational system. It will
also depend in part on our ability to attract talented people from other
countries, as we have in the past. It is certain that a number of our
basic industries, already under pressure, will move abroad, at least as to
generic processes with a high labor component.
About the author : Andrew Szabo, CFA, is Managing Director of Greenwich Financial Management Inc. , a Registered Investment Advisor. Questions or comments welcome by phone (203-531-2877) or e-mail ( Szabo@GreenwichFinancial.com ). Other research may be found at the Company's Website, www.GreenwichFinancial.com .