Some of us older investment guys are not the buyers of some youngsters’ views that “this time, it’s different.” Crucially, our young folk can have no benchmark against which to measure “this time”: as Einstein taught us, everything is relative.
Are markets “de-coupling”? If so, then why are US data still awaited and anticipated with such energy? And why is the US Treasury along with the G7's experts so worried about the international ramifications of America’s sub-prime mess? Or are global economies re-balancing? Respecting your time, we are going short on prose and long on staccato ideas below: you can connect some of the dots yourselves. Obviously this is a sketch, not a painting.
1. What is different
• Different sources of returns. The internet and cheaper travel – along with more foreign direct investment - are key factors that are forcing the governments of most emerging markets to treat their people better. And that boils straight down to income creation.
• New commodities demand. Because most emerging markets' governments have to create jobs, they need commodities. So, whereas in the 1970s “only” the G-3 mattered as commodity buyers, we now also see emerging markets fighting for resources. As an aside: this already is creating major geo-political sea changes, as you all know.
• Multinational Corporations. Look at how foreign direct investment into emerging markets is booming – inter alia because of the first two “differences”. Interestingly, General Electric (NYSE:GE) recently reported that its overseas revenues would surpass those of its US-based operations this year.
• Different debtors and creditors. The consistently marvelous Financial Times [FT] of 18th October mentioned that “emerging markets as a group are about to become net creditors for the first time, with international reserves of developing economies set to surpass the amount of foreign debt (that) they hold.” Of course this has to do with the first two differences: even non-democracies have to improve their governance, and many are commodities producers. Thus, they are creating more wealth – so up go assets and down go liabilities.
• Heftier capital flows. The FT also reveals that different groups now are investing in emerging markets: the aging societies of the developed world imply slower economic growth and thus lower portfolio returns, so up go the investments of their pension funds into emerging markets.
Also, with political and financial governance improving some of the bigger emerging markets, they become more attractive to traditionally risk-shy investor groups. At the same time, governments like China’s, awash with an excess supply of money (see last point), want to drain the bath tub, and thus are opening their own capital accounts. This means that Chinese now can invest abroad – either via the casinos in Macao, or via the markets in Hong Kong. The bottom line here is that if the local Economic Time is good, more foreign money pours in, exacerbating the economy’s excess supply of money. That, of course, propels markets according to The Economic Clock™.
• Choice. Crystallize all of these “differences” into one word, and “choice” springs to mind. Investors no longer “have to” invest “just in” submerging, i.e. developed markets, but also get to invest in emerging ones.
2. ...and what is not
• Returns matter. Are emerging markets really less risky than the developed ones? No! Surely you do not rate China’s, Russia’s, or Brazil's political stability on par with America’s or Europe’s, do you? As suggested in our first point above, emerging markets offer better returns.
• Bubbles and squeak. “Bailout Bernanke” is emulating his predecessors: “capitalists” and “free marketers” create a financial crisis, and sure enough, the good old “capitalist” Central Bank bails them out. Just as risk has lost value (witness the yield compression between G3 and emerging market debt), so has risk-taking: “capitalist” governments are ready to bail avarice out. And that normally has led to bubbles and crashes.
• G-3 remains supreme. Do you seriously believe that when America’s stagflation hits, or when people finally accept that The Economic Time™ is worsening in Europe and Japan, exporters like China won’t be affected? For your own wealth, please think again! And even if America’s and Europe’s imports were to continue – surely you accept that if/when their banks really get hit by sub-prime issues, we will face many global financial crises. Indeed, this is precisely why the US Treasury patched together the bank bailout deal a few days ago. All of which means that the real, as well as the monetary economies of the G-3, matter a great deal. Not to mention political combustions on Capitol Hill...
• Chaos. Finally, nobody can foretell, or later, even identify the “true” causes of a crash. And that won’t change this time!
3. How to make money off this
• Profit preservation. We have preserved profits twice over the past seven weeks: our funds remain exposed, but the profits generated have been parked into Sterling overnight cash.
• Choice. The Economic Time remains good for the likes of China, and thus, us water skiers in Hong Kong, but also in India and Malaysia. Keep exposure to these markets: they now are sufficiently liquid for you to move in and out of. Besides, if The Economic Time is good locally, more money flows in from abroad, exacerbating an excess supply of money which, of course, has to propel markets upwards.
• Commodity-producers. Definitely keep your exposure to these countries. For instance, I believe that over 60% of Australia’s commodity exports go to China.
• Avoid banks. Readers know our hesitation here: they are mendacious investments, as nobody knows the extent of their liabilities.