A couple weeks ago I mentioned that I like to sift through the stocks from unloved sectors of the economy in search of investment prospects. Readers of my monthly newsletter know that I report all of the changes in our portfolio, as well as many of the investments on my watch list, in the newsletter on the first of each month. For the last couple months emerging market stocks have been one group of companies that have been beaten down. While the stocks of companies in developing countries (like Nigeria) have continued to appreciate, the stocks of companies based in emerging market countries (particularly China) have trended lower. For this reason I have begun to build a position in China Mobile (NYSE:CHL), which you can read about here. In fact, I divided my purchases of China Mobile into four parts, and made my second purchase Friday at $41.57. Even the stocks of large multinational corporations have been punished, which is why I began initiating a position in Unilever (NYSE:UL) at $38.38 a few weeks ago.
Why have emerging market stocks, and the companies most exposed to them, been so punished? The fear is that global growth is slowing. I am actually confident that global growth is slowing, and the Chinese central government has told us as much (in China anyway). While I don't believe the stock or commodity markets have "predictive powers", I also don't think it's a coincidence that the Chinese government widened the Yuan's (China's widely traded currency) daily trading range from 1% to 2% last Saturday. If the Chinese weren't concerned about their slowing economy, they wouldn't allow the yuan to devalue against other major currencies, and certainly wouldn't allow it to devalue so precipitously.
Clearly, China's government is trying to devalue their currency in order to boost their export driven economy. (A devalued currency makes the goods one country produces, and sells overseas, less expensive. This methodology has been employed by many governments over the centuries, and often works in the short run.) For the last several years the yuan's value has steadily marched higher against other world currencies, and China has been been battling inflation at home. This trend reversal marks a major change of direction for China's government.
So you may wonder why I'm not bearish on China's economy? I do think it's likely Chinese growth will slow in the short run, but longer term I think China has a bright future… at least until its demographic issues catch up with it. Those demographic problems shouldn't really begin to drag on the economy for another 30 years or so, but make no mistake… the Chinese population in aging rapidly.
In the mean time, China's government has a delicate balance to achieve. They are trying to switch from an economy structured around manufacturing (for export) to a more balanced consumer based economy. I am sure there will be fits and starts along the way. I do not believe that China's stock market has bottomed despite negative returns the last couple years, but I also think most global stock markets will sell off substantially. In a week, a month, a year, who knows… My crystal ball is broken.
Fundamentally, I believe now is not a time to be investing a lot of new money in global stock markets, but I do see pockets of opportunities. I await the sell off with our portfolio largely in cash. Our long term dividend growth holdings are still producing income, but we are opting not to reinvest that money yet. As you can guess (based on my comments above), I will look to add to our emerging markets and consumer staples holdings on any substantial sell off.
Another area I believe will represent a good value, although not yet, are the "bond proxy" sectors. These sectors include telecommunications, consumer staples, and utility stocks. Investors which historically have had most of their portfolio in bonds, have instead begun to invest in these "bond proxies" over the last few years, seeking higher dividend yields than U.S. treasuries. When bond yields rise (and they will rise as bonds decline in value) these investors will transition back into the bond market. At that time, many of the dividend growth companies I love will be ripe for investing. I look to add to our positions in Coca-Cola (NYSE:KO), General Mills (NYSE:GIS), Johnson & Johnson (NYSE:JNJ) and initiate a position in Pepsico (NYSE:PEP).
It's not yet time for us to invest on a large scale, but the time is coming. Maybe we'll take a cue from the river and go with the flow, until the time is right. No asset goes straight up or straight down, not even stocks in a zero interest rate environment. I am extremely wary of domestic bonds with intermediate or long maturities. Some very good values can be found in the bonds of developing and emerging markets, however. Sometimes the toughest thing is to do nothing, and wait patiently.
Disclosure: Long CHL, UL, KO, GIS, JNJ. This article is for informational purposes only and should not be considered a recommendation for anyone to buy, sell, or hold any equities. I am not a financial professional.