Where to Invest Now for the Next 30 Years (Give or Take)

The largest economies 2011:

U.S., China, Japan, Germany, France, UK

The largest economies 2041: (30 years from now)

China, U.S., India, Japan, Brazil, Russia

If you have a long-term investment perspective and think globally about asset allocation, it may be time to review where you are invested internationally. If you are considering international investing you may want to consider a deeper analysis of these up and comers. Growth generated by the large developing countries, particularly India, China, Brazil and Russia could become a much larger force in the world economy than it is now – much larger than many investors currently expect.

Goldman Sachs issued an optimistic research report on global economies in 2003 which illustrated how China’s economy would overtake Japan’s economy as early as 2016. Well, they were right, kind of, it did happen, it happened in 2010. Maybe Goldman wasn’t optimistic enough.

A lot can happen over 30 years and there is a good chance that the right conditions in one or another countries economy will not fall into place and any projection will not be realized. However, if the BRICs (Brazil, Russia, India, and China) pursue sound policies (I’m talking mostly to you Russia) these projections may indeed become a reality. Remember, fifty years ago Japan and Germany were struggling to emerge from reconstruction. Thirty years ago South Korea looked a lot like North Korea looks today.

The progress of the BRICs will be critical to how the world economy evolves; they could become a dominant force in generating spending growth over the next few decades.

As developing economies grow, they have the potential to post higher growth rates as they catch up with the developed world. China's economy during the past 30 years has changed from a centrally planned system that was largely closed to international trade to a more market-oriented economy that has a rapidly growing private sector and is a major player in the global economy, not to mention the green economy.

There is a well-known existing econometric model from Levine and Renelt (http://www.fordham.edu/economics/mcleod/LevineandRenelt1992.pdf) based on cross-country econometric research that explains average GDP growth over the next the next thirty years as a function of income per capita, investment rates, population growth and secondary school enrollments. This closely matches the Goldman projections (in parenthesis) which employ a very different technique. The results are as follows:

Brazil – 3.3 (3.7) Russia – 3.5 (3.9) India –5.3 (5.8) China -5.8 (5.6)

These numbers predict robust average growth for these countries over the next several decades. Higher growth may lead to higher returns and increased demand for capital in these markets.

What are the implications? Well, the weight of BRICs in investment portfolios could rise sharply. The movement of capital might move further in their favor and significant currency realignments would take place.

As we become a shrinking part of the world economy, the accompanying shifts in spending could provide significant opportunities for many global companies like Coke and Caterpillar. Being involved in emerging markets is likely becoming an important strategic choice for many firms large and small.

Therefore, being invested in and involved in the right markets –particularly the right emerging markets may become an increasingly important strategic choice. While international investing does not reduce portfolio risk by a significant amount, it is measureable. And it does increase a portfolios expected return slightly and in the long run that’s what equity investors are looking for – whether stocks are 20 or 80 percent of the portfolio.

CP Blakely - CFP®, CTFA, CMFC 12/2010

Sources: CIA The World FactBook, Global Economics Paper Number 99 - Goldman Sachs, American Economic Review Vol.82 pp. 942-963

PIGS Headed Off to Slaughter

The largest financial crisis in history has spread from private to sovereign entities to paraphrase Nouriel Roubini, founder of Roubini Global Economics..Europe’s recovery will suffer and the falling euro will subtract from growth in its key trading partners. At its worst it conceivably precipitates a double-dip recession.

Now, governments everywhere are releveraging to socialize private losses and jump-start private demand. But public debt is ultimately a taxpayer’s burden. Governments subsist by taxing private income and wealth, eventually governments must deleverage too, or else public debt will explode, precipitating further, deeper public and private-sector crises.

This is already happening. Greece is first over the edge; Ireland, Portugal and Spain (yes, the acronym for these countries is pigs) trail close behind. Italy, while not yet illiquid, faces serious risks. Even France and Germany have rising deficits. UK budget cuts are starting. Eventually Japan and the US will have to cut too.

At home, recent data on employment, GDP and personal income highlight the complexity of information, which is sometimes contradictory and adds to the difficulty in making appropriate decisions. What the numbers suggest is that underlying demand in the economy remains subpar relative to the typical recovery. Therefore the rub is: there is a recovery (granted it’s a recovery only a statistician could love) but it remains disappointing relative to expectations and therefore disappointing relative to the financial markets - the Dow 30 recently fell from 11,200 in April to under 10,000 in early June.

This recovery is going to take more time to coalesce than those in the past. Job growth will remain disappointing compared to prior recoveries and therefore personal income and eventually consumption will be disappointing. Moreover, persistently high unemployment suggests the labor market is seeing lots more structural unemployment, which is a mismatch between the needs of employers and the skills and training of the labor force) compared to earlier recoveries. Slower growth is also associated with continued low inflation and steady interest rates. Yet, despite very low mortgage rates I don’t see a jump in housing starts any time soon. But given the current state of the Euro community and the headwinds facing us domestically, I continue to see a subpar recovery.

I’ve said it before and I’ll say it again. A successful portfolio funds your future needs or liabilities; anything short of this is a failure. It makes sense, then, that the portfolio must handle future events, not those of the past. Investment analysis uses past returns as the essential data for risk and return statistics. Consequently, the advisory business puts too much emphasis on past returns of funds and managers, when in fact it is subordinate.
Returns are the result of an economic environment. An economic environment has vast numbers of variables that play out in unpredictable ways. A portfolio defined today must play out in the uncertainty that is our future.
Proper diversification weights the portfolio toward asset classes with the strength to handle the future.

Since the stock market is not going anywhere anytime soon why not take a look at the debt side of your balance sheet. With 15-year mortgage rates at about four percent it may be wise to compare the cash flows of your 30-year loan to with those of a 15-year mortgage at the current market average of four percent (don't forget to factor in points). Running my own mortgage comparison, I found it was a cash flow push, meaning I would pay the same monthly mortgage payment on the 15-year note as I am on my 30-year mortgage, with one huge exception: my mortgage would be paid off 84 months sooner. That means huge interest cost savings (sorry Mr. Banker).

Christopher Blakely 07/02/2010

Sources: Roubini Global Economics, Bloomberg LP.