(Today’s post is a guest column from Forex Traders. – SmallIvy)
Current markets seem destined for a near-term correction, as exuberance over economic recovery data in the United States appears overly optimistic at best. After an amazing run up over the past seven months, the steam is already coming out of the balloon, as the S&P 500 Index has pulled back nearly five percent in the past three weeks. Now may be a good time to evaluate long-term trends in the market and to develop a long-term strategy for the years ahead.
The most dominant economic trend over the past decade has been the ascendance of the emerging economies of the world, often summarized by the “BRIC” anagram to reference Brazil, Russia, India, and China. Each of these countries, and especially their neighbors in Asia, has enjoyed real GDP growth that has doubled or trebled that seen in the Western world of developed economies. Although many investors are wary of current valuations in these markets, everyone from the IMF to major global economists are projecting these fundamental trends to continue.
Decades of off shoring activity has shifted the globe’s manufacturing base and related wealth factors to areas where labor costs are low and work ethics high. Forecasters predict great growth going forward, accompanied by volatility and pressure on currencies as a new world order emerges. China and India will be the big winners in this scenario of the future. However, you need not go to Asia to see these trends at work close hand.
Canada, our neighbor to the north, happens to have enormous oil reserves, second only to Saudi Arabia. The demand for energy resources from emerging economies has benefited Canada directly over the past decade. Its currency, often referred to in the forex market as the “Loonie”, reflects this success. Historical exchange rates for the “USD CAD” currency pair are depicted in the above 5-year chart. The Canadian Dollar has appreciated over 20% during the period versus the greenback, in line with a similar growth history for oil prices. The correlation between the Loonie and oil prices is clear.
If this type of trend is fundamental for the long term, what should a small investor do? There are a number of issues to consider:
- Diversification: Theoretically, a portfolio should contain a variety of holdings that are inversely correlated, so that if one goes down, another will rise in value to offset the loss. Investing in emerging stock ETF’s or even a few that are now devoted to specific currencies may offset the impacts of a weakening Dollar and take advantage of global growth dynamics;
- Asset Allocation: “Best Practice” for asset allocations from a portfolio for investing overseas has traditionally been 10% to 15%. Many pension fund managers have adjusted their parameters upward as high as 25% to 30%. Buying specific securities, however, can be risky. The best advice is to leverage the diversification that mutual or exchange-traded funds provide;
- Currency Risk: Investing overseas is a double-edged sword. Actual gains from overseas holding can be wiped out if our U.S. Dollar appreciates considerably during your holding period. Hedging this currency risk is best left to experienced professionals. An alternative approach would be to follow applicable exchanges rates to determine the impact that prevailing trends might have on your portfolio’s return dynamics. Projected volatility, however, is another matter. These fundamental trends are already causing strife in a number of regions of the world. The forecast is for a rocky road ahead.
A trader’s mentality of short-term buying low and selling high may be the best investing style over the next two decades and selling high may be the best investing style over the next two decades.