Roger Nusbaum's Market Crash Shelter

Roger Nusbaum submits: A reader asks for my opinion about how to protect against a collapse in the U.S. He asks if currencies or foreign stocks would help. Before I answer this, let me be clear I am not in the collapse-is-coming crowd.

I think it depends on the nature of the collapse. If the U.S. economy simply rolled over because of all of the things that are known and have been worried about for ages I think diversified basket of foreign currencies would work. There are the ETFs that I have written about. I also believe it is possible to have an account at Everbank with different currencies in it; here I am not talking about the CD's but just holding currency in an account.

Various commodities should do well also. Here the usual suspects like gold, silver, maybe some industrial metals that China steel needs and probably agricultural commodities too. I am sorry to report that the 29 commodity ETFs listed in London in September will not be available to trade in the U.S., so says Schwab. There are a couple of broad-based products here to trade that will have to suffice for now.

Foreign equities may not do well in a broad sense. The U.S. markets wag an awful lot of global dog. There are several types of countries that might be able to do well. The first type might be a country like Australia. It has a low correlation to the U.S. market and held up very well during the blow up of a few years ago. There are other commodity countries too like Norway, New Zealand and a few places in South America but I would not be too gung-ho on Canada in this regard.

I also think some "in their own world" countries might do well too like Turkey, Russia, China, India, and Iceland. Here the thought is that there are some countries where the internal story is such that there is not much reliance on the U.S. for these stories to continue evolving.

In a similar vein I think certain frontier investment destinations could keep chugging right along with or without the U.S..

There are certain themes that could prevail, here the water theme comes to mind. Now I may or may not be right about water prevailing but there would be special themes that would work out.

Staples stocks or certain healthcare stocks should do better overall be would probably not be completely immune to a big decline.

If you think foreign stocks would be a good place to hide out, OK, but watch out for iShares EAFE (EFA). It is heavy in Japan and the UK which would not be places I would bet on in light of a true collapse.

Domestic bonds might not be so great; I would think U.S. rates would go up a lot in the face of an economic collapse.

One last point on this. There are often a lot of comments in this context about owning dividend paying stocks. Be careful with that one. I think it is too broad a statement. Yes high dividends bring something to the table, but stocks of companies that pay dividends can still decline. During the U.S. blowup of a few years ago the financial sector had a couple of different times where it fell 20%-25% very quickly. I mention the financial sector because it makes up 36% of iShares Select Dividend (DVY) (client holding), in fact most of the domestic dividend ETFs are heavy in financials and I would not expect that sector to be a great place to hide in the event of a collapse.

I would also be careful, in this context, with Powershares International Dividend Achievers (PID) (client holding). When PID first listed it had 20% invested in Canada including 13% in Canadian banks. Eyeballing the PID page it appears to be not quite as heavy in Canada but it still owns close to 10% in Canadian banks (under the sector header NA). Again this is about my opinion that in a U.S. collapse Canada would not be spared. I'm a big fan of Canadian banks ex-collapse, I own one personally and for clients, but I would expect it to get hit in the context of this question.

As an FYI most of the broad based WisdomTree funds are heavy in financials, but they do not invest in Canada which might make them an alternative to PID in light of a collapse.

If the collapse came because of a terror attack on some unprecedented scale I would expect the dollar to go up along with bonds, gold and the Swiss franc.

Comments

[JohnWilliams]

Let me see - the largest consumer of everything in the universe crashes and someone is looking for something to protect his whatever's left? You've got to be kidding, right? If we go everybody goes - it truly is that simple. And then we'll all pick ourselves out of the ruins and go on - just like 1929. So stop worrying and just accept whatever comes - remember the best time to buy is when the market is down.

[RogerNusbaum]

a dollar decline in light of a US collapse does not seem to be a stretch. certain foreign currencies would in fact go up agianst the dollar even if the stock markets in those countries did not.

[Mike Higgs(akayielder)]

<i>Again this is about my opinion that in a U.S. collapse Canada would not be spared. I'm a big fan of Canadian banks ex-collapse, I own one personally and for clients, but I would expect it to get hit in the context of this question.</i>

If you are talking economic collapse of the US, there won't be anyplace to hide. If you're talking about somthing on the scale of the "U.S. blowup of a few years", then your concerns about large-cap, blue-chip dividend payers are generally misplaced. Yes, you'll see price declines but the dividends are likely to remain intact absent a catastrophic economic collapse. Canadian banks are no different in that regard from any other major global bank. They have taken huge earnings hits at various times over the last 30 years - oil patch loans in the late 70s, Third World debt in the early and mid 80s, the deep recession of the late 80s/early 90s, dot.con loans, Enron-related fines but none has ever cut a dividend. Dividends have been frozen for a couple of years and the rate of increase has slowed at times but the dividends have remained intact. If the dividend is determined to be safe and sustainable, then price declines are a fabulous opportunity to buy an income stream at a bargain basement price. Having said that, diversify because s*** happens.

Mike

[RogerNusbaum]

For my concerns to be misplaced you must believe that a 4% dividend today would give solace to a 30% decline tomorrow? I for one do not. Also note I said nothing about dividend cuts.

[Panskeptic]

"I am sorry to report that the 29 commodity ETFs listed in London in September will not be available to trade in the U.S., so says Schwab."

There must be something in there that US regulators find toxic. Somebody has written that if you are thinking of buying them through an international broker, if the account is identified as belonging to a US person, they'll sell you out without notice. If this is true, it's a deal-breaker.

[Anu Menon]

"I also think some "in their own world" countries might do well too like Turkey, Russia, China, India, and Iceland."

Great article.. Its interesting that you've mentioned China &amp; India as 'in their world' ..don't these countries depend(especially china) on US export, IT trade etc and US VC/PE investments?

[RogerNusbaum]

Where China is concerned I think first and foremost about the modernization underway and the raising of the middle class. We would still buy socks and t-shirts at Walmart from China but we may buy fewer $100 sneakers. IMO the hit hit to GDP would be less than some folks think.

I have owned one of the oil stocks for many clients and a telecom name for some clients.

India as an outsourcing destination could see a net benefit.

[mslasky]

Given that degree to which china's foreign reserves are in US treasuries, and the magnitude of their exports to the US, not a good place to hide if the USA "blows up". I'd suggest international water utilities - an essential commodity not linked to the US dollar.

[GeoffConsidine]

Hi All:

An alternative approach is just to build a low Beta / low R^2 portfolio:

usmarket.seekingalpha....

Similarly, I have pointed out that Warren Buffett's equity portfolio exploits these kinds of effects. The kinds of low Beta / dividend yielding stocks mentioned in the article above have lower correlation to the U.S. markets than most broad foreign ETF's: EWA (the Autralian ETF) has a 60% correlation to the S&amp;P500. That is lower than something like EFA, but still not the best you can do. EWA also has 86%+ correlations to EFA and EEM. By contrast, consider than KO (one of Warren's favs) has a correlation to the S&amp;P500 of 36% and to EFA and EEM of 27% and 11% respectively. There are many more good examples with low Betas and decent yields. You can easily build a portfolio with higher yields than the dividend yielders and that are largely de-coupled from the S&amp;P500.

For providing the best de-coupling from the U.S. market but staying in equities, the broad country-specific ETF's are not, IMHO, the best solution.

[RogerNusbaum]

using 7/1/2000-12/31/2002 as a real world stress test KO declined 25% while the SPX declined 40%-according to bigcharts.com. To readers, something i said elsewhere, would a 3% yield be much solace in the face of a 25% price decline? I specificlly touch on this above in the post. If you can be on board with that type of action, and to Geoff's credit you probably should be, fine but in the context of exploring ideas that avoid a collapse I think this is a lousy example.

BTW KO is down about 18% from July 1 2001 through today.

Go to bigcharts.com and play around with the dates yourself.

[GeoffConsidine]

Hi Roger:

A couple of things. First, my article looks at portfolios with low R^2 and Beta in aggregate. Looking at a single stock is not the right way to do this. The portfolio that I show in that paper weathered the bear market quite nicely. This should always be about portfolios. You need to combine a series of stocks or funds which are each relatively volatile but exploit low correlation among them. If one stock goes down 25% over two years, that is kind of irrelevent---it is about the total portfolio. Also, I make the point in my article on low Beta strategies that you must also set the total volatility (risk) that you can live with. You will be able to find the right balance of portfolio components once you know how much risk you want to bear.