It’s a Charlie Brown Year
“Stop worrying about the world ending today. It’s already tomorrow in Australia.”
Remember good old Charlie Brown? He would appear to make progress in this world and, whenever he did, the rug always seemed to be pulled from under him. This is one of those years for all of us. The market seems to get ahead; then something pops up out of the blue. Before Friday, June 23 (see my Brexit article), international stocks were up for the year and have now gone negative since the vote. Luckily, emerging market stocks are up 10%, while U.S. stocks and bonds are up 3 to 5%.
Actually, this has been the story of international stocks for the past five years. During that time, there have been numerous crises worldwide: the U.S. debt downgrade, Greece leaving the Euro (Grexit), slowdown and currency crisis in China, and now Brexit. In each case, the markets never saw the result coming. Looking back though, these situations were all great opportunities to invest. This time is no different.
So what should you do? First, realize that this is just another crisis, if you can call it that. The U.K. will still exist, business will carry on as usual, and trade between the U.K. and Europe will continue; maybe in a different form, but it still will exist. Although there is still a contagion concern, this crisis soon will be forgotten and, before long, something new will replace it. As a value investor, you actually want this. It provides an opportunity for the value funds to pick up cheap investments.
Picking an Approach
Many clients are asking about portfolio positioning. Most updates I’ve read from the large brokerage houses discuss the benefits of avoiding U.K. stocks, waiting it out in high-quality assets, and moving to a risk-neutral position. This type of thinking led investors to pull a net $8.4 billion out of foreign-stock mutual funds last quarter – a reaction that probably made famed value investor Benjamin Graham roll over in his grave.
This “sitting on the sidelines” approach is the opposite of what he (and I) would recommend. Look at the banks in Europe, for example. There are issues, granted, but relative to the U.S., European bank stocks are very cheap. Right now, Barclays and RBS (two of the largest U.K. banks) are trading around 30 cents for every dollar of assets, while HSBC is at 60 cents. Moreover, the European bank index is trading for about 85 cents per dollar of net assets, while, in the U.S., the bank stock index will cost you $1.30 for every dollar of assets. Big difference. As always, investors tend to oversell what’s out of favor and overbuy what is in favor.
Why would anyone sit on the sidelines when they can buy at bargain-basement prices? We take advantage of opportunities like this via the value funds in your portfolio, which by definition, automatically pick the stocks falling out of favor. Therefore, don’t be surprised to see U.K. bank stocks becoming a bigger part of our international funds. It’s a strategy that has paid off with countless other scenarios like this one.
The Bigger Picture
The Brexit is a microcosm of a large issuer happening worldwide that all comes down to the globalization of the economy. Every country is struggling with its residual effects, including immigration and jobs going offshore.
As populism and nationalism take hold worldwide, let’s hope the world does not go the way of Germany, Japan, and Italy in the 1930s. Xenophobia was rampant then too, and this vote in Britain highlights the immigration issue occurring not only here in the U.S. where there are rumblings of a wall being built along the Mexican border, but also in Japan, Austria, and France where some political parties are making this topic their primary platform – and gaining popularity by doing so.
Over the past 15 years here in the U.S., almost 66,000 factories have closed costing more than 4.8 million jobs. Sounds bad, right? However, when you hear this, don’t forget to ask about all the jobs that were created during this time. For example, Amazon now has over 200,000 employees, Apple employs more than 60,000, and it is estimated that over 600,000 jobs have been created outside Apple to support the iPhone operating system. When you combine these examples and others like them, things don’t look so bad in aggregate. However, converting factory workers into HTML programmers is virtually impossible, which causes a wide disparity between the rich and poor. Consequently, globalization, free trade, and immigration are viewed negatively by the majority of the population.
As we’ve seen the past couple weeks, it’s not an issue isolated to the U.S. It’s happening everywhere, and thus, tension is rising among the populace. Hopefully, our country won’t go the direction of England, but if we raise walls and increase tariffs, we will follow the same isolationist path.
With all that said, don’t lose sight of the positive effects of globalization. For example, as Great Britain gets smaller and more isolated, India, with its 1 billion people (England has a paltry 53 million), will surely overtake Britain’s standing in the world during the next couple of years. India represents 3% of the global GDP (England is about 4%) and had the fastest-growing market last year (at 7%). What’s more, they announced three days before the Brexit vote that they were opening up their market more to foreign investors, but with all the talk about Brexit, no one seemed to notice. That’s unfortunate because this change means foreign investors now are able to invest 75-100% in many Indian industries, which is a giant step forward for a country with a long history of protectionism. In other words, while the old guard builds walls, the new up-and-comers are breaking them down.
This reiterates the fact that emerging market funds should play a significant role in any portfolio. That’s why India and China represent close to 30% of our emerging markets fund.
Again, this Brexit issue soon will pass and be forgotten. Focus on the positive effects of globalization and stay diversified among many countries. The bigger news will be the U.S. presidential election, which should heat up after the conventions in late July. Hold on to your seats!
Lane Steinberger, CFA, CFP®
Partner, Chief Investment Officer