Performance over time and country allocations

The table below shows the development of several leading indices over several time periods. It stands out that ytd, China is the best performing market, followed by Korea. Both of them show more than double the returns of the MSCI world (ACWI). More interestingly, however, are the performances over the longer, 5 year term (as we are investors, not traders). While it is always difficult to draw general conclusions, it appears that countries with a larger share of industrial production and who, in the main, consume commodities, have significantly outperformed those countries who are mainly producing commodities. With the price for debt (interest) also bring at historic lows (and in some cases, such as Switzerland and Germany, negative - ie. you have to pay their governments to take your money!) it is also not surprising that countries who live off financial services (where debt/money is the commodity) have not performed particularly well in relative terms. With the BoE having raised interest rates last week for the first time in 10 years, the Federal Reserve Bank letting some of its bonds mature without replacement (tightening monetary base) and the ECB halving its monthly purchases of Government bonds to €30bn, there are signs everywhere that the decade of cheap money is coming to an end (or at lest stop getting cheaper). So what does that mean for your country allocation in your portfolios. Well, first of all, we have to make the somewhat daring) assumption that, reducing the monetary base and/or increasing interest rates can happen in an orderly form, without upsetting the markets. In that case , we would expect economies that live off financial services to a large extend to benefit from the steepening of the yield curve (Banks getting access to money/savings at lower short term rates, but being able to lend at higher rates at longer term). This, therefore, favours the UK and Switzerland. With the cost of debt (interest)going up, over time, the cost of commodities (more expensive to finance mines, pesticides, fodder, etc) would go up, increasing inflation and, more importantly, inflation expectations and in turn, would favour economies such as Australia, NZ and Canada. Therefore, if your view is that we are at the beginning of the reduction of the monetary base and/or interest rate increases AND that this can be achieved in an orderly form without upsetting the markets, you should start shifting your portfolio weighting’s towards those countries. However, the big IF is, if this can be achieved without shaking the markets. Far from reducing debts since the crisis in 2008, governments around the world have actually increased their debts - and so have companies and households. Companies over the last decade have increasingly used financial engineering to make use of cheap debt available, ie they have increased debt and/or reduced cash on their balance sheets to finance dividends or share buy-backs, which in turn drove up thrift share prices. Household debt has also increased in the developed world and stands at record levels. As debt ceases to be cheap, this will lead to increased debt servicing difficulties and ultimately defaults on all levels, State, companies and households. It is this scenario of a reduction of monetary base/ interest rate increases that in my view poses the biggest risk to markets at the moment. All other risks that we always talk about (Brexit, North Korea, Middle East, Trump, etc) the markets seem to shrug off - as long as there is cheap money to feed the frenzy. Should we experience a major sell off (which, statistically, we should expect every 3-5 years, depending on what time period you take as a base, and have not now experience for 9 years!), of course, all markets around the globe will be affected as investors scramble to take profits where they can. However, markets that have risen strongest (and with good volume), are likely to be held in portfolios most widely and therefore more prone to profit taking and larger falls. Hence, despite the fact that All markets will be negatively affected in a crisis (remember: the only factor that goes up in a crisis market is correlation!), the “laggards” in the table over the last 5 years may still be the winners. In the light of the above, it may be time to review your country weighting’s in your portfolios and, despite the fact that current returns are below inflation and therefore post risk to your capital in real terms, a healthy dose of cash in the portfolio may well be advised even to the serious long term investor. 

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