21st Century Requires Global Investing
Investors in the United States purchase securities (i.e. stocks, bonds, mutual funds, ETFs, etc.) predominately in the United States. Often 90% – 100% of their total portfolios. When the USA dominated the global economy this approach may have made sense. But it is a flawed strategy in the 21st Century. Consider the following issues.
Today, the United States makes up only about one quarter of global GDP. The basic requirements of diversification dictate that investors look further afield. If you had four baskets would you put all of your eggs in one? That’s what you’re doing when you invest only in the United States.
Despite recent volatility foreign markets, particularly in Asia, are expected to make up 80% of economic growth in the 21st Century, according to the IMF. In twenty years’ time the majority of Global GDP will be in Asia and other Emerging Markets. Not the United States and Europe. Achieving adequate portfolio returns will require investing around the globe.
Emerging Markets often have better debt-to-GDP-ratios than developed countries like the USA and Japan. Today, the United States has total debt exceeding 100% of US GDP. Japan stands at 229% of GDP. In many cases economies outside of the United States are better managed, with lower debt-to-GDP Ratios, and debts denominated in local currencies, which mitigates the risk of financial crises that used to be a more prevalent risk with debts denominated in U.S. Dollars.
Emerging Markets have younger populations, with lower labor costs and higher growth. This results in growing companies and investment opportunities. Many countries across the Middle East and Asia have more advanced and modern infrastructure than the United States. This leads to higher productivity and investment returns. In many cases these countries have a well-educated work force, with advanced skills. Think software development in places like India and China. Other countries like Germany emphasize highly-skilled vocational occupations. This has helped Germany to become a large exporter of goods. Nearly one-half of German GDP is made up of exports. In the United States the figure is only slightly more than 1/8th of total GDP.
Investors often assume that the United States is “safe”, and the rest of the world is “risky”. But this is a naïve view. Japan has had tepid economic growth for nearly three decades, as it relies on repeated rounds of monetary stimulus to drive growth. This approach has consistently failed. The United States has amounted more debt in the past decade than it has in the prior three decades. Like Japan we have an aging population, which will leave the labor force and require more expensive healthcare services. Millennials will spend more of their earnings supporting people who’ve left the labor force. This will subdue growth as funds are redirected from investment and spending in the broader economy to supporting the basic needs of a growing and aging population. In a more pessimistic scenario, investing outside of the United States may be a way to mitigate risk.
The United States seems to be going down the path of protectionism, with a number of populist Presidential Candidates advocating tariffs, opposing trade agreements and other nativist and sometimes xenophobic views. Protectionism was embraced during the Great Depression and made it much worse. It will do so again. The United States runs large trade surpluses in services. Things like software, Google Search and bio-technology that have high value and drive economic growth. Current Presidential Candidates seem to want to kill off these strategic US Industries with a trade war in order to bring back low-skill manufacturing jobs. They fail to realize that those jobs are already gone and won’t come back, having been replaced by automation. Start slapping large tariffs on imports from countries like China and watch them do the same on iPhones and Boeing Airliners. Chinese Airline Fleets made up of Airbus A350s & A380s will put vast numbers of people out of work in the USA and lower the stock prices of companies like Apple and Boeing. Agreements like the TPP (Trans Pacific Partnership) give U.S. Corporations stronger legal rights in places like China. This helps U.S. Firms protect their intellectual property, expand operations, increase U.S. Exports, and create more U.S. Jobs. A more export-oriented U.S. Economy resulting from stronger trade agreements leads to job and economic growth, especially for U.S. high-tech firms, that need better legal protections overseas in economies that present growth opportunities.
The United States is often a less attractive option for corporate investment (and therefore stock investing), because of its slower growth, aging population, and increasingly difficult environment for running a business. The USA also has a 35% corporate tax rate, far higher than most other countries. That’s why US Corporations leave Trillions of Dollars stranded overseas, and want to use “tax inversions” to re-incorporate in places like Ireland. Whether or not you think this is “patriotic”, corporations have a responsibility to their shareholders to maximize financial returns. If US Tax Policy encourages them to act accordingly then the USA needs to examine its tax policies if it wants to drive economic growth. “Shaming” corporations into being “good citizens” simply won’t work. Re-invigorating economic growth in the USA requires government and tax policy that incentives corporations to repatriate Trillions in Cash to the United States, and invest it at home. So long as better investment opportunities and more friendly tax policies remain abroad then US Corporations will act accordingly. Likewise, the average investor seeking higher returns should diversify with a portion of investments made abroad.
Presently, most markets outside of the United States have much more compelling investment fundamentals, with P/E (Price to Earnings) Ratios often at 1/2 – 2/3rds of P/E Ratios for U.S. Equities. While Large Cap U.S. Equities recently have sold off by no more than 11% from their highs of May, 2015, most foreign markets have already seen declines of 30-50%. They’ve already experienced a Bear Market and, in many cases, are now outperforming U.S. Equities. In contrast U.S. stocks have yet to experience a Bear Market (since 2008/9). As a result U.S. Stocks may present more downside risk and more limited upside potential over the next few years. Diversifying your portfolio around the globe reduces this risk.
Finally, we should consider that too many Americans still have a limited set of experiences outside of the United States. A majority of Americans have never traveled outside of the United States. Those that have generally opt only for convenient or “safe” locations like Mexico, the Caribbean or Europe. Most Americans learn everything they know about the world from their television or the Internet. Too often what’s presented is a distorted and scary picture. So long as Americans have limited, firsthand international experience they will perceive “home” as being “safe” and the rest of the world as being “scary” and “risky”. Too often this mindset leads investors to employ a 20th Century Approach, with most or all of their portfolio invested strictly in the United States. Go somewhere new. Some place outside of your comfort zone. You’ll stop seeing the world as something to fear, but rather as an opportunity. You’ll no longer see the rest of the world as a “risky” investment but as new markets that present an opportunity.
Successful investing requires a considered, more expansive view and a recognition of evolving trends. It requires decision making based on informed choices, and not emotional and xenophobic views. It requires pushing beyond the familiar and searching for new opportunities. In short, an ever evolving and globalized world requires that investors take a more global investing approach in the 21st Century.
Peter Gaylord, CFA
Gaylord Wealth Management, LLC
535 Mission Street
San Francisco, CA 94105
+1 (415) 971-7529
pgaylord AT gaylordwealth.com