Stock prices have been declining, commodities are nearing their lows last seen during the 2008–2009 credit crisis and yields are falling as money is attracted to safe-haven investments like the 10-year U.S. Treasury and the German 10-year bund. Volatility has increased in the markets once again as investors are worried about the possibility of slowing global economic growth, and China has garnered all the attention this week by suddenly devaluing their currency.
China is trying to manage their economy towards a consumer-driven model from one more dependent on real estate, new factories and other credit-fueled projects. Relying on the Chinese consumer means a slower yet more reliable pattern of economic growth. As the second largest economy in the world there will be hiccups in China’s transition, and it is these hiccups that the world is eying. Still investors should remember that (per World Bank forecasts) GDP growth in China for 2015 ranks #15 out of 175 countries at 7.1% as compared to the U.S. at #105 with 2.4%.
The latest occurrence to capture the market’s attention is a devaluation of the Chinese currency (Yuan) starting on Tuesday, August 11 which as of the close on Wednesday, August 12 had gone from 6.210 Yuan per one U.S. dollar to 6.387, or a 2.5% decline. The Peoples Bank of China has worked diligently for the last 20 years to manage the Yuan to be stable, or even strong, relative to the U.S. dollar. In fact the Yuan has appreciated 15% versus the dollar since 2008, and our government has been very critical of the Chinese for not letting their currency appreciate at a faster rate than that. This currency strength attracted foreign investment to China, but made life hard for Chinese exporters because their goods became more expensive on world markets. Imagine you (in the U.S.) are purchasing a product from China that has gone up in price 15% since 2008, simply due to currency – you are likely to find a less expensive substitute from Europe or Japan where currencies have declined versus the U.S. dollar.
There are many layers to this issue, but let’s address just two:
- Should the long-term investor have any meaningful allocation to China and other emerging economies, especially where currency issues add to volatility? We believe the answer is absolutely YES and the reason is primarily to participate in the higher level of economic growth this region has when compared to the more developed world. Further, both dividend yield (at 2.7% for MSCI Emerging Country Index versus 2% for S&P 500) and price/earnings ratio (at 11 for MSCI Emerging Country Index and 16 for S&P 500) signal attractive valuation today and the opportunity for future gains in emerging markets.
- Should the long-term investor have any allocation to commodities, given that worldwide concerns about China growth (among other matters) have commodities trading at multi-year lows? We believe the answer varies, but those investors willing to take a tactical approach that could take 3 to 5 years to pay-off are likely to be rewarded when commodities recover. In particular we like North American energy related opportunities for this allocation.
As we see sell-offs in emerging markets (which could well accelerate in the near-term) and in commodities, we are somewhat reminded of the 2008-2009 credit crisis when nervous investors sold risk assets of all types pushing prices down to incredibly low levels. With hindsight, we now know that event represented a great buying opportunity. As many line-up to favor one side of the trade (low yielding bonds and highly valued U.S. stocks) we prefer a meaningful allocation to the other side of the trade. It may mean more portfolio volatility, but we believe that exposure to volatility will be rewarded over the long-term and that is the time horizon for which we’re investing.
These current events are complex and ever changing. You are wise to work with a team of experienced professionals to help you make wise decisions today and in the future.
Published: August 13, 2015