BIG JOE CLARK: Do you need foreign exposure?

May 10, 2008 08:02 pm

— There are tipping points in almost every economic and market cycles, where everything looks feels and seems excepted as common fact; perhaps you should start to go the other direction! Sounds contrary, and it is, but don’t forget to look here at home for some of your investment dollars.
We have maintained a full allocation in international investments the last four years. A full allocation in our mind means that 40 percent of our equity exposure was tied directly to investments overseas. The same can be said for Harvard’s endowment as well as a few other nationally known financial organizations. At the same time, the largest pension funds in our country held an allocation of less than Harvard’s, while the average 401(k) plan participant had less than 8% allocated internationally at the beginning of 2007 according to reports on Seeking Alpha.
After three spectacular years of results for the emerging markets and even large foreign exchanges, many of the pension funds decided the world as they knew it had changed and announced a serious shift in allocation last October. We used that knowledge to warn our readers that volatility could very well increase. Even we were surprised by January’s market gyrations but some of it was telegraphed. When people try to play catch up things can get out of hand very quickly.
We won’t go as far as saying that things have gone too far but we do want to point out some interesting issues and circumstances that are causing us to look at home as well as abroad. The first issue is purely from technical analysis in terms of relative strength. Relative strength essentially pits two or more investments together over different time periods to see how they do against one another. Ideally, you want to select investments that go up more in good markets and down less in bad markets. That seems very common sense but we see it misused and misunderstood by many investors.
We use multiple software programs to track the entire U.S. Equity market versus the world, the emerging market regions, everything but the U.S., etc. Interestingly enough the most improved category over the last 90 days according to our research has been the United States. Keep in mind that is no guarantee that this will continue or that the U.S. even had the best absolute return since March 18 – a critical day in our view point for watching financial flows and market internals. In other words, relative strength points to the U.S. as a place for some of your dollars.
That again may not be surprising to you and you may be thinking that you already have most of your money allocated to the United States. True enough and we are in the same boat. Keep in mind that our "friends" across the pond also have capital to allocate and they are seeing the same charts that we are. We could see a resurgence of foreign investment into the U.S. equity markets. This type of investment is far different than Sovereign Wealth Funds investing in our markets.
Secondly, we pay great attention to U.S. institutional money flow and the numbers have been surprising as of late. There was close to $3.6 trillion in money market accounts and we expected to see a draw down the first three weeks of April as people and corporations prepared to pay for their tax bill – and indeed we did. Now the draw down – and it is very large – seems to be heading directly toward the equity market. Again, relative strength recently being in the U.S. would lead us to believe these out flows on money market funds are going directly to U.S. equities.
Then there are the fundamental issues. The big story appears to be that the U.S. dollar has finally begun to stabilize and even rise a little. The foreign countries in the Euro region have watched their currency appreciate at a level that has made their middle class appear rich when visiting the U.S. – look at Disney’s numbers from the Magic Kingdom this week for more on that story. As the dollar attempts to find a base it is natural for the money centers in Europe to buy our stocks at a cheaper price.
A key thing to watch will be the interest rates in Europe. Germany is a large exporter and the weakness of the dollar relative to the U.S. dollar has put serious strain on their economy. Ideally, for them, the U.S. dollar would appreciate on its own but if it does not we think the ECB – the equivalent of our Federal Reserve – could possibly buckle and cut rates. That action would oppose their stated economic mandate but many economists are suggesting this could occur. That would also help U.S. equities in theory.
The only downside to the above is that the companies within our S&P 500 have been having more of their earnings attributed to overseas than here at home. The dollar rising in value will impact those earnings. The hope is that they would be offset, by increased earnings here in the states.
There is never any guarantee where markets are headed in the short term and we are not attempting to imply otherwise. Our job is to find the best places to allocate capital based on what we know, what we see, what we believe to be true, and to where the evidence seems to be pointing. As faithful readers we thought it was only fair to share with you what we deem to be a potential "a-ha" moment.
Joseph "Big Joe" Clark is a Certified Financial Planner and the managing partner of the Financial Enhancement Group, LLC. He is a registered principal offering securities and Registered Investment Advisory Services through World Equity Group, Inc, member FINRA/SIPC. Big Joe can be reached at bigjoe@yourlifeafterwork.com, or (765) 640-1524