The Foreign Equity Conundrum

There was an article in the NY Times Sunday titled "For Foreign Stocks, The Sure Bet Is Over." As is often the case the headline writer sensationalized the article a tad but there are some important things to think about if you are one to invest in foreign equities one way or another.

A few years ago there were some especially cheap areas in foreign and emerging markets and many of those areas are no longer cheap. I saw elsewhere that Petrobras (PBR) used to trade with a mid-single digit PE ratio, then a couple of years ago it had close to a US market multiple and now it's higher than the US market. This isn't necessarily a reason to buy or sell the name, if oil does go to $200 in short order, as some think, PBR is likely to go along regardless of the valuation.

PBR is an example for many emerging market stocks that are nowhere near as cheap as they used to be. This should not be a shock to anyone, in the last five years emerging markets, as measured by iShares Emerging Market (EEM), are up by 250% versus less than 50% for the S&P 500. The risk for emerging markets, obviously, is greater after a 250% run.

Zero exposure creates a very big bet but if you have any exposure now you are taking more risk than five years ago and so should you have more or less exposure than you did five years ago?

Developed Europe appears to be economically vulnerable - very vulnerable - these days. The housing problems in some places might be worse than in the US, the rolling over of some economic data from the continent seems worse than the US, many commentaries paint the UK as being in dire straits making the pound an obvious sell. One commentator very amusingly said if he could figure out how to do it he would sell the pound against the pound.

The Shanghai Composite, as most folks know, is down over 50% in nine months, generally worse than other Asian markets. Is China an outlier, in terms of magnitude, or a leader of sorts and so other big declines will soon follow?

In simple terms there are maybe two big macros out there right now. One is that there is a global slowdown occurring in many places that we can perhaps attribute to excesses galore and escalating inflation. The other macro is the commodity boom and whatever that will ultimately turn out to be. Sorting those out might mean some countries do poorly and some do well, or maybe all countries buckle under the weight of inflation in certain prices and asset (house) deflation.

For purposes of this post I am not trying quantify or give an opinion on what these things will mean. These are some of the issues that world markets have to confront. While markets always confront risks, foreign equities have been a one-way trade that have offered fantastic outperformance. In that light a set-back seems reasonable. That is not a call for US equities to do better than foreign but that save for several in their own world destinations, don't let global equity price declines catch you off guard.

Demand for stocks is unhealthy now and most people understand that. In this environment, while the risks for foreign markets are greater than the were, the more important thing, in my opinion, is in one way or another, taking some sort of defensive action in the portfolio be it more cash than normal, inverse ETFs, puts, whatever.

There are times to go along for the ride up (most of the time) and times where defense makes more sense. Defense has been the key for quite a few months now and could be for a while longer.

Comments

[johnthebear:]

Sound advice. Beware of BRIC markets. They are all trending lower, and will go down a lot more as the global recession takes hold.

2008 Jun 23 02:38 PM

[poopoo:]

I agree, a good defense. is the best offense.

2008 Jun 23 03:56 PM

[Stockaccumu...:]

Read Cramer's article "Stop trading and buy Brazil", greatest article her ever wrote, just published and out today... copy also found on Seeking Alpha... he is so right recommding PBR. Buy PBR now today, forget about it, and double your investment by summer 09' easy... only other to guarantee such a result is to buy SID (also in Brazil, Steel, ore, mines)... there is a brief break in the price of these two companies... buy now... The Stockaccumulator...

2008 Jun 26 12:47 PM

[blink0404:]

Hey Roger Nusbaum fans,

Here's a link to an Roger Nusbuam interview with Chip Hanlon on greenfaucet.
www.greenfaucet.com/no...

They discuss the market and why Nusbaum thinks there could more downside for stocks to come.

2008 Jul 02 03:58 PM