Earlier this month, Jeannette wrote a very informative piece on the recent problems in Greece, providing historical perspective, facts surrounding the current state of affairs and breaking down the impact to clients and their portfolios.
Around that same time, it seems as though many other spots in the world went haywire as headlines highlighting trouble in markets of all shapes and sizes were in the news, if not somewhat muted by the Greek crisis. This week, let’s look at some of those headlines from what’s been a volatile summer in the markets and break down the numbers, what’s behind them and the impact to portfolios.
Perhaps the most notable headline overshadowed by the soap opera in the Mediterranean was in China, where the stock market fell by nearly a third in June, a loss of $3.5 trillion in wealth. To put that figure in perspective, that’s more than the entire value of India’s stock market. Many stories cropped up that the ripple effect and pending doom would be felt throughout the world.
Instead, within a week, based on drastic actions by the Chinese government and some natural rebounding after such a loss, markets started to recover.
Pulling the lens back a bit, it’s important to note that, at the end of May, China’s market had grown 150% for 2015, meaning this dramatic drop in June still left the market up 75% for the year. It’s also worth noting that the stock market still plays a very small role in China’s massive economy. The government only allows a certain percentage of GDP and household wealth to be invested in stocks. It has a lot of control in what domestic shareholders, even company owners can invest or divest at any time.
That said, this is one of the more serious market tests the rising giant has faced and maybe the first true challenge of leaders’ beliefs that they can allow free market economics to work in a highly controlled, communist state. How they’ll handle things going forward will ultimately tell the tale. While these leaders have managed tremendous growth to date despite their distrust of free markets, China needs to show it has proper understanding of them as it intervenes to get things back on track.
Despite its size, because of state limitations, China represents just 3% of the world’s investable marketplace. While smaller than many think, that still places it amongst the largest of the emerging markets.
While we seek to mirror the world marketplace in our portfolios, we also limit exposure to emerging markets somewhat as, while making up 12% of the world market, the asset class historically is just too volatile to hold in those proportions.
As an additional layer of conservatism, Dimensional Fund Advisors, in its management of our emerging markets strategies, caps any one market from representing an outsized portion of the fund. Steps like these allow investors to be spared the inevitable growing pains of rapidly growing countries as they ebb and flow between emerging and developed while still participating in some of their long term solid returns.
A headline many missed in the financial press amidst the panic in Greece and China was the tough times hitting our neighbors to the North. Canada was heralded during the global economic crisis of the last decade for its prudent lending methods, reasonably conservative spending and ability to profit from then rising oil prices. Now, there are sudden fears that housing prices have risen too sharply and that an over-reliance on natural resources and commodities, which have been hit too hard by decreasing exports to the U.S. and other markets, may be too much for their economy to bear.
Throw in a very weak Canadian dollar recently trading at just $0.77/CAD, quarterly data pointing to a mild recession and formerly popular Prime Minister Harper facing a now challenging October re-election bid, and the next several months should be interesting for the Canadian people.
We recently had the opportunity to visit with several Canadian financial advisors who came to Cincinnati to learn how American advisors compared to their methods, allowing us to hear first-hand about some of their challenges. Like in the U.S., many Canadian investors have home bias to companies from their homeland. Many Canadian equity portfolios invest 1/3 in Canadian companies, 1/3 in U.S. companies and 1/3 in the rest of the world regardless of the fact that Canadian companies represent just 4% of world market capitalization. This bias may prove costly to Canadian investors if they’re unable to recover from the lack of economic diversity in some way.
Canada represents 4% of the world market and is proportionately represented in the developed market funds we utilize. This asset class makes up a larger percentage of the equity side of our portfolios than emerging markets. So, is there cause for concern? Not exactly. Historically, there are always various markets in some state of struggle or recession, but one of the many benefits of diversification is the ability for that temporary poor performance to be counterbalanced by other developed markets. While it was Canada that helped counter some of the losses in the last decade’s downturn, it’s now other markets carrying Canada while it manages through its struggles.
As a brief example that these issues don’t just occur outside our borders, we turn to the U.S. territory of Puerto Rico. The island’s governor recently admitted that the $72 billion debt carried by the territory is not payable. Non-employment is somewhere around 60% and the welfare standards in the area often make it more advantageous not to work than to find a job. None of this is sustainable.
Puerto Rico is stuck between being a territory that has no Federal bankruptcy protection, and one that enjoys much of the same municipal bond structure as the rest of the U.S. This has created a perfect storm where debt is easier to come by than it might be were Puerto Rico to stand on its own, but finding any protections for repayment are challenging.
In the grand scheme of things, Puerto Rico’s debt is something the U.S. can easily absorb. By comparison, during the 2008-2009 debt crisis, the U.S. lent financial institutions as much as $700 billion dollars while they recovered. But this hasn’t gone unnoticed in Washington as this crisis is allowing for Congressional representatives from Puerto Rican heavy areas in New York, New Jersey and Florida to bring attention to necessary reforms.
This is another area where broad diversification is an excellent protector of client assets. Over the last many years, many investors have turned to Puerto Rican municipal bonds as a place to chase slightly more yield while enjoying many of the same tax benefits of municipal bonds in the 50 states. Ignoring the clear difference in risk versus the available return is done, as always, at investors’ peril. Avoiding the chase for higher yields, while sometimes painful in the short term, continues to pay off as our fixed income portfolios have not been noticeably impacted.
Looking at Greece and the situations above is not meant to explain away onetime events in isolation or to tell clients to simply ignore headlines. In this age of rapid, constant information flow, that’s an impossible task.
It’s more a reflection that these types of challenges are constantly present in the market. It’s why we build portfolios to be resilient in good times and bad and choose to spread our bets across markets across the globe. Everything we do in markets in based on logical, academic evidence. The only bet we have to make is that these markets, over the long run, will continue to innovate, develop and find new ways to thrive and grow.
Despite problems in the European Union, Canada, and the ripple effect caused by China in the Asian markets, where do International large and small companies fall in returns so far this year? 6.14% and 9.24%, respectively as of this writing, two of the best performing asset classes year to date. Another indication that headlines do not always equate to investor returns.
A lot of this information comes from a variety of white papers and other resources that go much deeper into these issues and their impacts. If you have any interest in more detailed analysis, feel free to contact the office.
Have a great week!