If you have not done so, please read this article Mr. Buffett wrote for Fortune in 2003.
What caught my attention in this article was not the plain and obvious negative outlook for the dollar, but instead remembering how the United States became an economic powerhouse after WW2. I was curious to look around and see if any countries today resemble the post war to 1970s United States. If so, what would the criteria be? I boiled it down to six. Their weightings are included (6 being most important).
- External Debt/GDP - 5
- Median Age - 1
- Last Years GDP Growth - 4
- LPI (Legatum Prosperity Index) - 2
- Tax Revenue % of GDP - 3
- Current Account Balance % of GDP - 6
Here is my explanation for each criteria and the process I used to achieve a score for 30 countries.
- While some people are looking to Central/South America and even Africa for growth, that growth comes with the enormous risk inherent to developing countries. I therefore started by limiting my search to the top 30 countries as ranked by the 2010 Legatum Prosperity Index (LPI). The LPI consists of 79 variables mostly centering around the socio-economic building blocks of society. This step weeds out investing in places like South Africa and India that still present too much risk to the average retail investor.
- I then ranked those 30 countries by median age (the best getting a 1 and the worst getting a 30). Aging economies place large financial burdens on both government and the working class. This step can discount places like Japan where the median age is 44.6 and identify opportunities in places such as the United Arab Emirates (UAE) where the median age is 30.
- We hear a lot about PIIGS and sovereign debt issues, and the problems in those countries are often reflected in their external debt/GDP and their current account balance as a % of GDP. If a country owes too much to debtors outside its borders, it is forced to pay increasingly larger interest payments that eat into their budgets, and ultimately force delicate situations. Any economist knows that running continuous and increasing deficits is never sustainable, and this criteria also received an important weighting.
- In the end we're looking for countries that can produce above average GDP growth, so naturally, we should look at last year's GDP growth. Although the past is never a reliable indication of the future, economies don't change as quickly as companies, so I believe it's still important to include this figure in the weighting.
- Lastly, I wanted to identify countries that already supported much of their "size" (GDP) in income (tax revenue). I look at this as almost a price/sales (P/S) ratio for countries. This is not to reward socialist political schemes, but merely to emphasize that if a country is forced to lower a deficit, doing so through changes to the tax code is preferable to changes in spending. The latter is more time consuming, often harder to accomplish, and can have severely negative impacts on different sections of the economy.
Below are the results. As in golf, the lower the score the better.
Seeing as the PIIGS nations are in the red and China is one of only two in the green, I think we can take these results as being somewhat significant. What's interesting to me are the results in yellow and orange. The Nordic countries and Uruguay seem to offer some safe opportunities for growth in the future. Both the euro and U.S dollar don't look like smart trades short term, and investors should be careful of holding resource intensive currencies like the NZD, CAD, and AUD.
One way to take advantage of this information would be buying the Singapore dollar while selling the Kiwi (SGD/NZD). For those less interested in the actual currencies, buying the iShares MSCI Singapore Index (NYSEARCA:EWS) can give great long term exposure. Ultimately U.S investors with time horizons longer than 5 years will be smart to hedge their equity positions. ETFs and currencies are great ways of achieving this without the risk of speculating in foreign (and less well regulated) equity markets.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. My views are solely my own and not reflective of the investment strategy of any firm I have worked for or currently work for.