Big Picture Investing: Stay Above The Political Fray

Includes: EZU, FXI, QQQ, SPY
by: Roger Salus


Political discourse tends toward misrepresenting macroeconomic trends investors need to be aware of.

No better example exists than the widespread confusion/ignorance regarding the decline in the U.S.'s standing in global GDP and manufacturing.

Comparing the longer-term returns on broad-based ETFs can give investors a better picture of economic reality from that of politicians and the news media.

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The following is intended to help fellow investors protect themselves from the myths of political punditry, and prevent it from negatively affecting our returns. I hope to show that we need to occasionally divorce ourselves from political loyalties and left-right labels. Two important macroeconomic trends from the last half-century or more are shockingly unknown to many investors. The cause and nature of the U.S.'s supposed economic decline and shrinking manufacturing sector reflect this. Understanding these trends can help you make decisions on where broad-based ETFs like the iShares China Large-Cap ETF (NYSEARCA:FXI) or the SPDR S&P 500 Trust ETF (NYSEARCA:SPY), for example, should fit into your portfolio, or to what extent changes at the polls can derail your big picture investment strategy.

The U.S.'s Alleged Economic Decline

Let me be clear, there are numerous ways in which economies can decline, and the following does not try to address them all. That said, there is no debating the fact that the U.S.'s share of global GDP has been steadily trending downward for at least 60 years. This has occurred in conjunction with post-World War II growth in foreign economies. Broad-based ETFs, like FXI or the iShares MSCI Eurozone ETF (BATS:EZU), are an effective way individual investors can profit from macroeconomic growth in countries outside the U.S. With the much-ballyhooed decline in the U.S.'s share of global GDP, it would be only too easy to allow the U.S.'s allocation in your investment portfolio to decline, too. So what is the bigger picture regarding the U.S. economy's role in the world?

At the conclusion of the Second World War the U.S. was in a dominant position economically. While much of Europe and Japan lay ruins, the U.S. by contrast emerged with an intact infrastructure and industrial base, and a super-charged manufacturing sector supporting a war economy. As the post-1945 peace set in, the U.S. could boast over 50% of global GDP. It was a good time to be an American worker, too. Factory jobs abounded and paid well. There was little foreign competition as most industrialized countries lay in ruin. Since then, of course, the U.S.'s share of global GDP has slowly fallen to roughly 24% of global GDP today.

The reason for this decline should be obvious. With the war over, Europe and Japan started growing and producing again -- rapidly. They had a lot of catching up to do, what with having to rebuild entire countries and all. As these economies came back online their GDPs rose, and their respective shares of global GDP increased. The U.S.'s share inevitably had to decrease. It could not have been otherwise. Now add to the mix the emerging markets, like the Asian Tigers, and then later China, India, and others. These countries' GDPs rose rapidly as they industrialized, and their respective shares of global GDP increased also, and yes, the U.S.'s share necessarily decreased even further. Indeed, from the early 2000s to present China's share of global GDP has increased spectacularly, with numerous years of 10% growth or more, meaning that the downward trend for the U.S. continues.

None of this is necessarily bad news for the U.S. All it means is the rest of the world is growing, and while that carries with it increased competition it also means new markets are opening up. However, when politics intrude good news can become bad news.

Recently I came across a typically misleading article, this one from the right-leaning Forbes, which makes much ado of the U.S.'s decreased share of global GDP without so much as mentioning the historical developments I just mentioned. Instead, the author attributes this decline to such factors as over-regulation and an unfriendly US business climate. By beginning his trend-line in 1960 the author obscures the fact that U.S.'s decline in global GDP actually began a decade earlier, and is irrefutably tied to the post-war global recovery. Perhaps we should expect this from Forbes, as over-regulation and an "unfriendly" business climate are favorite themes of the pro-big-business right.

This betrays the nature of political discourse in the mass news media. We are affected emotionally when we hear our country is in trouble. We seek causes and crave solutions. The political class understands this, and is ever at the ready to assign blame and insist that its solutions are best. Reasonable people can certainly debate whether the U.S. has an unfriendly business climate or is over-regulated. However, to offer these as the cause of the country's declining share of global GDP is either dishonest or naive.

As a casual investor you might hear all the hullabaloo about the U.S.'s decline and lose focus on reality. Namely, the U.S. economy has by and large grown quite nicely over the last 60 years of "decline." In that time it produced a litany of impressive companies as diverse as Microsoft (NASDAQ:MSFT), Google (NASDAQ:GOOG), Wal-Mart (NYSE:WMT), and McDonald's (NYSE:MCD). As an investor this matters. If you choose to turn your back on the U.S. and focus on, let's say, a sexy up-and-comer like China, your returns might not reflect the collective wisdom heard in the press.

Let's take a popular broad-based China ETF, like FXI for example, and compare it to a couple of equally generic ETFs in the "declining" U.S. Just for comparison, since its inception in October 2004 FXI is up roughly 295%, though experiencing considerable volatility. Not bad. Yet, over that same period a plain-vanilla investment in the S&P 500, say through SPY, would have returned 242%, with a bit less volatility. Not that big a difference, especially when you factor in the comparatively lower volatility experienced by SPY. However, an investment in the U.S.'s dynamic technology sector, say an ETF like the PowerShares QQQ Trust ETF (NASDAQ:QQQ), would have yielded a 453% return over the same period. Pretty good for a collection of companies in a declining economy burdened by a hostile business climate.

Meanwhile, an investor who bet on Europe, say by using the broad-based EZU ETF would have enjoyed only a 41% return over the last fifteen years or so. Not bad, but poor when compared to the aforementioned returns from the U.S. (or for that matter from China).

This is not to dissuade anyone from investing in China or Europe. It is good to diversify part of your assets to more than one jurisdiction. Nor is this to suggest that the U.S. does not have structural and/or political problems. However, the U.S. stock market, particularly the technology sector, clearly deserves to be over-represented in your portfolio.

The Decline of U.S. Manufacturing

Unlike the U.S.'s declining share of global GDP the decline in manufacturing is not a ruse. Jobs have been lost and communities have suffered. Furthermore, the statistics are irrefutable.

Since the end of the Second World War, manufacturing's share of employment has fallen from close to 40% of jobs to the current level of roughly 10%. The following chart shows this long-term trend quite nicely.

Source: The Federal Reserve Bank of St. Louis

People understandably become emotional when they see this, and for good reason. The decline of manufacturing employment in favor of a service-oriented economy has meant a wholesale change in many people's fundamental way of life. The stability that seemed to permeate work life in the 1950s, with greater unionization, company pension plans, and jobs for life, has been almost completely displaced in just four or five decades. Enter politics.

Remember the reasons for the U.S.'s declining share of global GDP? Well, now apply what we discussed to U.S. manufacturing. Clearly, the nearly 40% number at the end of WWII was not sustainable. With the inevitable decrease in arms manufacturing you would expect to see a large drop off in the years immediately following hostilities. Indeed, that is what we see. And remember all those nations rebuilding their national economies and infrastructures? Well, as more former manufacturing powerhouses, like Germany and Japan, came back online so too did they compete for the global consumer's spending money. Even more importantly, however, automation and technology's unstoppable march has made manufacturing less dependent on workers, and more dependent on machines. Indeed, manufacturing's share of global employment has been declining worldwide. It is not an exclusively U.S. phenomenon. We may or may not like these developments, but it is the reality we live in.

Throughout the 80s and 90s, through repetition in the mainstream media it became accepted dogma that the loss of U.S. manufacturing jobs was a Ronald Reagan phenomenon, and blame was often placed upon the shoulders of that administration by countless media pundits and outlets alike. Even today the mantra continues, as can be seen in this recent column in the left-leaning New York Times where economist-turned-pundit, Paul Krugman, claims that, under Reagan "the long-term decline in the share of manufacturing in overall employment accelerated sharply." This is an interesting claim, especially in light of the actual facts. Indeed, a few years previously yet another left-leaning daily, The Washington Post, released a telling piece where the exact opposite phenomenon was observed and documented. The full quote is worth reading:

If someone had cornered you in 1980 and asked you to predict what the level manufacturing employment would be at in 2009, and you did a straightforward linear projection of the previous two decades, you would have gotten it almost exactly right. You wouldn't have known about the fall of the Soviet Union or the rise of China or the scale of advances in international communication or automation, but you still would have gotten it almost exactly right.

In other words the rate of decline in manufacturing employment during the Reagan administration was no different than during the previous two decades, and no different than during the Clinton administration, and so on. The author tellingly describes this as a wholesale change in the way people think about the decline of manufacturing. Indeed. Could the impetus for this sudden epiphany by a left-leaning daily be that President Obama was himself facing criticism at the time for the decline of U.S. manufacturing employment?

You may counter by dismissing all this as punditry and not reflective of the news media at large. However, as the author himself alludes, most people, regardless of education, are grossly misinformed or ignorant of this trend. It demonstrates the woeful job the news media has done at educating the public on politically divisive issues. As both voters and investors we are doubly vulnerable to political myths.

The global macro trend in place since at least the 1950s still holds the greatest sway on manufacturing's role in national economies. That trend can be seen here, and it is a global phenomenon. Of course, people can argue that various administrations should or should not have reacted differently to this trend, but there is no denying the downward slope has remained intact through at least eight administrations from both parties, and it is actually global in nature.

Investors need to be cognizant of the claims we hear not only from politicians (whom we expect to obfuscate), but especially from the news media (whom we naively expect to rise above politics). For decades candidates from all parties have routinely lamented the loss of manufacturing jobs, while laying blame and promising solutions. The slogan "make America great again" may be unique to President Trump, but the message is hardly new. Recall the 1992 presidential campaign when Democrat Paul Tsongas' wanted to "restore America's economic greatness." This issue is a prime example of why we should often ignore the national screaming match. Instead, research and invest in companies that specialize in the automation technologies taking over manufacturing, rather than waiting for politicians to reverse trends that are beyond their control. The U.S. economy, while suffering some very ugly warts, nevertheless has dynamic and growing sectors, and the gains proffered to investors largely reflect this.

Politicking Can Be Bad for Your Financial Health

As investors we need to step back from our own political biases and loyalties from time to time. I say "step back" because we all suffer from the all-too-human mental defect called "politics." We can never truly rid ourselves of our precious humbugs.

It is true that the U.S. now only accounts for about 24% of global GDP. However, I believe I have made a strong case for a much larger allocation than 24% to the U.S. economy. I share people's concern about shrinking employment in the manufacturing sector. However, the main drivers for this development are global growth and industrialization, and more importantly the march of technological change. As individual investors we cannot change these developments, and neither can politicians. We can, however, tune out the politics as best we can and invest in the changes that are irrevocably shaping the world.

Let the news media portray each election as some Manichean struggle between good and evil, but the truth is that the chasm between what politicians say and do is astonishingly wide. Not that elections are irrelevant, but as investors we need to keep them in perspective. We also need some healthy skepticism for the news media. It is simply a business, and its unstated job is to grab our attention, sensationalize, stoke emotional responses, push the agendas of its owners and editors, and confirm the biases of its customers. Our business, on the other hand, is making -- or at least trying to make -- good financial decisions. Seeking out the true big picture can only help with our task.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.