Investing in equities has never been an easy game, but today it has become especially difficult when you consider how much depends on the decisions of policymakers.
Here in the United States, right now no progress is being reported on fiscal cliff talks, despite the decidedly short amount of time remaining before more than $600 billion in automatic tax hikes and spending cuts kick in. We still think some sort of compromise will be reached, if only another temporary solution to our financial problems.
If that happens, corporate America will undoubtedly breathe a collective sigh of relief, and then - perhaps - put some of the mountains of cash it's sitting on to work. Together with a housing sector on the mend and consumers feeling more confident than they have in the past five years, it could all translate into even stronger growth here at home, and higher stock market averages in the year ahead.
Then again, we can't rule out altogether the possibility that Washington fails to get its act together and we go over the fiscal cliff. In that scenario the inevitable result will be a contraction in the economy and the stock market before galvanizing the Dems and GOP to finally take action.
Europe, meanwhile, is going nowhere fast. Even the strongest economies across the continent are feeling the pinch caused by troubles in the southern "Club Med" countries. Greece is being kept on life support with financial aid.
But the best solution, which would be a real plan for fostering growth, has yet to materialize. And until such a plan is put into action and/or Greece's debt is forgiven, the region's overall economy could continue to struggle. Central bankers are trying to do their part; they have the monetary throttle open wide and stand ready for even more asset purchases.
From the valuation standpoint, and considering the marginally improved regulatory outlook, European stocks are starting to look attractive. But until there's more clarity on the debt situation, the risk of investing there will remain high.
Government policymakers' prescriptions for dealing with current challenges in the economy on both sides of the Atlantic are analogous to stepping on the gas and the brake at the same time. That is to say, if and/or when they decide to take their foot off the austerity brake, the high revving stimulus policies are likely to cause their economies to spring forward explosively in a cloud of burning rubber.
Looking further east: Japan, the world's third-largest economy, contracted by 3.5 percent in the third quarter on an annual basis - and the fourth quarter is shaping up to be equally bad. If so, it will mark the fifth time in the past 15 years that Japan's economy has fallen into recession.
Japan is less concerned with austerity, but still has a tough road ahead. To combat this situation, Japan's government is adding more stimulus, announcing a new fiscal package last week worth 880 billion yen ($10.7 billion), while the Bank of Japan expanded its asset purchase program in October to about 91 trillion yen ($1.1 trillion). Moreover, Shinzo Abe, the presumptive next prime minister after elections are held in a couple of weeks, has vowed to take additional monetary measures to drive down the value of the yen to spur the economy.
One bright spot in the global economic landscape, despite its many detractors today, is China. That country's economy appears to be stabilizing and is likely to accelerate in the months ahead. We learned recently, for instance, that China's manufacturing activity increased last month for the first time in more than a year. This is the latest in a string of reports in the last few months supporting a turnaround in China's economy. The de-stocking cycle there appears to be ending, and the rebuilding of inventories coupled with greater investment and government spending on infrastructure should drive domestic demand higher.
China's stock market today is reminiscent of the United States, circa 1982. Investor sentiment is in the cellar, and stocks are trading at extremely low valuations - with blue chip shares in many cases selling at low single-digit earnings multiples. We can't say when the bear market will end: it could be tomorrow, or it may take a year or two. But when it does end, the market is likely to take off like a rocket.
Still, we would tread very carefully when attempting to invest there. One need look no further than the disastrous performance China's solar companies turned in during the past four years, when even the most successful companies saw their stocks decline by 95 percent - at the same time, their global market share was soaring.
The safest way to play this market is with a diversified fund. Our hands-down favorite is China Fund (NYSE:CHN), a closed-end fund that invests in a mixture of public and private (unlisted) Chinese companies. It therefore offers an opportunity for U.S. investors to tap into investments generally reserved only for Chinese investors. The China Fund currently sells at a 9 percent discount to its Net Asset Value [NAV], meaning that when you buy a share in the fund, you're getting all its holdings for 9 percent less than what you'd have paid had you bought them individually.
The fund's investment approach, moreover, holds long-term promise: unlike the majority of other pooled investment vehicles that are market-cap weighted, China Fund applies a fundamental growth approach to its portfolio selection. The result: a portfolio whose 15 largest holdings account for more than half of total assets, but where China Bright, a healthcare company in which the fund has made a direct investment, is a position of nearly twice the size of China Mobile, the world's largest telecom provider by subscribers.
A more traditional approach is utilized by iShares FTSE 25 China ETF (NYSEARCA:FXI). It reflects the largest and most investable part of the Chinese/Hong Kong market. The biggest sector is the financials, at more than half of the ETF's assets, followed by telecoms, including China Mobile, at 17 percent, and energy stocks, at 15 percent.
Still another way of profiting from China's coming economic revival (and an avenue for greater wealth even if we're wrong and the Asian giant merely lumbers along) is with gold-related investments.
China has made no secret of its desire to diversify its vast foreign reserves with gold. Its actions suggest that China's leadership is working toward ultimately establishing a yuan that is at least partially backed by gold. China is mining gold at an unprecedented pace (none of which is exported), the government's current holdings are at least several times official reserves (figures for which haven't been updated in more than four years), and Chinese consumers can't get enough of the metal, either. Faster growth will only add to their zeal in buying gold.
And of course, as we discussed earlier there's all that stimulus being pumped into other economies, which has the potential to spark inflation on a scale not seen in this country or most other developed economies since the late 1970s.
The yellow metal has essentially been in a trading range for more than a year, but that's fine with us, since it has allowed us more time to accumulate. One day in the not-too-distant future, however, gold will once again be off to the races. A doubling of current prices would not be the least bit surprising.
Our top choices for gold investments haven't changed. You can buy gold itself via the SPDR Gold Trust (NYSEARCA:GLD). For gold shares, our preference is toward the small cap miners that make up the MarketVectors Junior Gold Miners Index (NYSEARCA:GDXJ); these companies have the potential to generate tremendous returns in the coming years as they grow their reserves with pick and shovel.