It may not look like it but the world’s stock markets are about to start moving in different directions.
That’s certainly not at all clear now. Most days recently all the world’s stock markets have moved in the same direction—DOWN. On June 29, for example, the U.S. Standard & Poor’s 500 Index dropped 3.1%, Germany’s DAX Index fell 3.3%, and China’s Shanghai Composite Index plunged 4.3%.
But I think sometime in the not too distant future—somewhere in the next three to six months would be my best guess—the stock markets of the developed and developing world will start to diverge. Six months from now—or less—stocks in China, Brazil, India, and many of the other developing markets will be in clear up trends and stocks in the developed economies of Europe and Japan will still be stuck in decline. The United States will be left in the middle, straddling the divide between the two groups.
Why?
Because the underlying economies are headed in radically different directions within that time period. And where the economic fundamentals go, stocks, eventually, follow.
If I’m right, this divergence should be the cornerstone of your investment strategy over the next year or longer. And, if I’m right, how you allocate your portfolio between these two diverging blocks of economies and markets will determine how well your investments perform during that period.
Let me lay out the case for this divergence in the economic fundamentals-and stock markets. And then you can judge for yourself if I’m right or not.
The recent G20 meeting of the world’s 20 largest economies marks a good starting point for looking at the economies of the developed world.
And when we look, what do we see?
Annual government budgets that are deeply in the red. The U.S. budget deficit is forecast at 10.6% of GDP in 2010. The United Kingdom is forecast at 10.1%. Spain is forecast at 9.1%. France is at 8%. Japan at 6.4%. Germany at 5.5%.
How bad is that level of deficit? Economists estimate that a budget deficit of 3% of GDP is sustainable. Above that a country is piling up debt that it can’t repay under reasonable assumptions of growth (and manageable inflation.) In the long run that leads to falling growth rates, climbing interest rates, and finally fiscal crisis.
That’s why the final communiqué from the G20 made such a big deal of two deadlines. First, leaders of the G20 agreed that they would aim to cut their annual deficits in half by 2013 and, second,  to stabilize or reduce the total government debt to GDP ratio by 2016. That’s tantamount to a call to reduce annual budget deficits to 3% of GDP or less.
The leaders of the G20 were careful not to call any of this an actual agreement or even a promise. These were goals, aims, expectations. (For more on exactly what the G20 meeting did or didn’t achieve see my post https://jubakpicks.com/2010/06/28/dobt-expect-the-bond-markets-to-cheer-the-g20-results/ )
But still, as loose as the timing in these aims is, as vague as these promises turn out to be, as good as the odds are that no country in the group will actually achieve these goals, the agreement does indeed describe a broad economic trajectory that goes like this: high-deficit developed countries will cut government spending over and over again during the next five years or so. The cuts aren’t likely to be serious enough to end the debt crisis in these economies so the total package over time will include less government spending, higher taxes, slower economic growth, and rising interest rates.
As a fuel for stocks, that’s got about as much bang as a wet squib a week after the Fourth of July. But that’s the course that countries such as France, Spain, the United Kingdom, and maybe even Germany, have chosen.
Contrast that to the path that the world’s big developing economies are headed down in the years between now and 2013 or 2016, the years in the G20 press release.
Brazil, India, China and other developing nations don’t have huge debt from the financial crisis and subsequent stimulus spending to pay off. For example, in Brazil the government deficit is currently running at about 3.24% of GDP. The IMF (International Monetary Fund) estimates that the ratio of government debt to GDP in developed economies will rise to 110% by 2015 from 91% at the end of 2009. In comparison in April 2010 Brazil’s government debt amounted to just 42% of GDP and is headed down to 30% of GDP by 2014, the Brazilian government estimates.
That’s not just the stabilization that the G20 aimed for as a goal by 2016 in its recent press release—it’s an actual decrease in the burden of government debt on the economy. And the decline in debt and the restrained spending pattern is one reason why a country like Brazil earned its first ever investment grade rating from Standard & Poor’s this year.
Not to say that the world’s developing economies don’t have problems. China has got an asset bubble in real estate and a run away money supply that threatens to send inflation soaring. Inflation in Brazil is running at better than 5.2%, way above the government’s target of 4.5%. India is facing similar inflationary pressures.
And there’s a very real possibility that measures to control inflation—interest rate increases or increases in bank reserve requirements—will overshoot and, combined with the slowdown in growth in the developed world, send economic growth rates in China, Brazil and the rest of the export-oriented economies of the developing world lower than expected. That’s certainly what the market is afraid of at the moment. (For more on the current state of fear see my post https://jubakpicks.com/2010/07/01/markets-get-spooked-now-that-china-is-delivering-exactly-the-slow-down-they-wanted/ )
But look at the very different nature of the problems facing the developed and developing groups. Too little growth and the possibility of even more slowing in the developed world versus too much growth and the possibility of a stumble as governments there try to keep growth under control.
And look at the very different time frames for working out those problems.
In the developed economies we’re looking at a very long, slow grind back to fiscal stability. Years. 2016. Even if politicians and voters decide to take the pain that doing what’s necessary will entail.
And in the developed economies we’re looking at a very real possibility that in the time period I’m talking about—now through 2016—things will get worse before they get better. More unemployment. Slower growth. Goodies like that.
And that’s not even considering the very real possibility that we’ll all—politicians and voters—decide to shirk the hard work and opt for the easiest short-term solutions. That puts us in the developed world in a truly horrible position to face the really big problems that will arrive by 2030 when an aging population catches up with all of the world’s major economies (with the exception of Brazil and India where demographics don’t get nasty quite so quickly.)
In the developing economies, we’re looking at relatively short-term risks of lower than projected growth, the bursting of an asset bubble or two, and higher interest rates. But the worst of that will be over by the beginning of 2011 in all likelihood.
Brazil, for example, looks like it will stop raising interest rates in 2010. (For more on how this schedule is playing out in Brazil see my post https://jubakpicks.com/2010/06/29/looking-for-good-news-today-try-brazil/ ) India too. China is well on the road to refinancing its banking system (using techniques for burying bad debt developed in the late 1990s to fix the excesses of the Asian currency crisis). If not this year, then next. And that will put worries about a real estate bubble to rest. (For more on why China might really be broke—if the accounting were honest—and how China plans to bury the problem see my post https://jubakpicks.com/2010/03/12/despite-those-huge-reserves-china-could-be-gasp-broke/ )
In other words developing economies still face pain but it’s short-run pain. And it’s likely to be over by the end of 2010 (or sooner in some cases).
So by the last quarter of 2010 the world will look like this, in my opinion:
In the developing economies, promising signs that worries about slower than expected growth can be put to rest, an end to interest rate increases, and increasingly solid-looking government finances (at least relatively.)
In developed economies, worries that growth is still very slow—so slow that a slide back into recession remains a possibility—and a background of budget cutting and rising deficits (as the budget cuts turn out to be less than advertised as they always are.)
The United States will fall somewhere in between the two groups although obviously much closer to the developed economy track., The Obama administration hasn’t yet drunk the Kool-Aid of budget cuts ala Germany and the United Kingdom but Congress isn’t likely to pass any more stimulus. And I doubt that the administration will be able to avoid major budget cuts, even if economic growth is anemic, after 2011. So the United States might grow more strongly than the rest of the developed world in the near term but eventually it too will have to deal with its fiscal mess.
Now like biology, macroeconomics isn’t destiny. But I’d sure much rather have my money in stocks with the fundamentals of developing economies behind them than in stocks with the fundamentals of developed economies stacked against them.
See a hole in that argument? If not, you know where to put your money once the sell-off in global stocks is complete, and developed and developing stock markets start to diverge.
I would expect and China to start selling automobiles in the US soon. Any idea what company would be a good bet to invest in? I would take Kia’s business model as an example for the Chinese company, except on a much larger scale.
Awesome Jim, Thanks for the reply!
johnsonle9,
We’re in the process of adding platforms like Ameritrade one at a time. Vanguard looks like it will be first in the next week or 10 days. (We’ll announce it never fear.) And we’ll set it up so that if you invest through Ameritrade or Schwab or whoever, you still get the JAM newsletter for free.
Jim, I want to purchase JUBAX in my IRA, any idea when Ameritrade might list it? And if I buy thru them, do I still get the newsletter?
Off topic, Santander is doing well last few days. Good call by Jim.
I am sick and tired of reading the political commentary in this space. The facts are that EVERY administration has spent money the COUNTRY did not have! I am sick of Obama saying that he will call on Congress to make some “hard choices” -after the election of course! Why not now! What is he waiting for?! Oh could it be that taxes need to go up to covwer the trillions he has spent on health care?! I don’t care anymore! Live within your means. California, NY and a bunch of other states are the perfect examples of bad management.
The US is broke. The government is not the way out-business is and the last guy in office who got it was Reagan.
Jim is right- look to countries without the debt and uncontrolled spending that the West is addicted to!
bsdgv,
good comment. i agree with what you say. I think the hangover is not nearly over for the USA. I also agree, in general with Jims’ knowledgable article. Yet, one the interest rates rise in the USA – thats when there will be hell to pay.
Jim said: “The Obama administration hasn’t yet drunk the Kool-Aid of budget cuts ala Germany and the United Kingdom but Congress isn’t likely to pass any more stimulus.”
But i think Congress WILL past more stimulus. They will be too afraid of social unrest and loss of votes from the unemployed. When the stimulus does end – it will be ugly.
I am still using DRV and TZA. They seem well-suited for this environment.
Did anyone see how the market gapped up this morning only to lose momentum in what seemed like a few moments? I just can’t help feeling this is not a market to buy into.
In response to poster # 1 YX
Off Topic:
TOT -CEO “oil at 90”
Boone Pickens called for 200 oil right when it hit its peak at 147. Then it went to 38.
Aubrey McClendon , CEO of CHK said CHK would hit 100 share by 2008. It went to 7.
Go to Vegas with your money boys…you’ll have more fun. Guaranteed!
In general, I agree with Jim. I would add though, and I believe he would agree, that one should NOT view the US market as monolithic but as tiered. Our DJIA, for instance, is made up of mega-companies that will benefit from the growth in developing countries. Other US non-DJIA companies, like Nike, who market world-wide will also do well. It’s the smaller US companies, Russell 2000-3000, who have little or no global reach who will do relatively poorly.
Further, the US is the largest consumer market in the world, and as it falters, as Jim predicts it will, then those developing countries whose economies export heavily to the US will do less well, UNLESS their domestic or non-US consumption rises to fill the gap.
This is precisely what Geithner was saying to the leaders of developing countries recently at the G20 conference…you cannot depend on the American consumer like you once did. You must stimulate domestic consumption. Of course, that will be good for our multi-national companies, as well.
To summarize, think like a global producer with a global comsumer and invest accordingly.
Instead of following a thundering herd into emerging markets. Just look north to a stable developed country Canada.
Jim,
IMHO, a necessary condition for BIC to continue to grow while the developed economies stagnate is a rapid increase in consumption inside the BIC economies. Do you have any numbers on that?
Jim, you spoke about the opportunity in emerging markets but only gave brazil and china as examples. Can you pls help us understand why u think that India and Russia are also in that high growth, low debt, low risk bucket?
Its not that Obama didnt do anything in 2 years. His problem is a) too much of an “academic” and surrounded by academics – who see everything as a problem looking for a NEW solution.
b) clearly acts like a newbie who is suddenly is put in position to make a difference and so wants to maximize his short stay. His few moments of glory – he will go down in history as a parallel of Carter.
c) just plain unlucky – he is always holding a “leaking pot” – starting with the Congress. Was fortunate to start his term with an incredibely supportive Congress and he will end up loosing it compeletly.
d) Simply doesnt realize that solution to the financial and most of other crisis does not mean more regulations – typical academic/socialistic thinking. What it requires is better execution and implementation and few people being thrown in jail. But no – we have to find a solution that is sufficiently impressive and massive!
e) Has to stop opening his mouth too much. Again does not realize that the “honeymoon” period is over – most people now interpret his words as empty and an attempt to hide something and indication of more uncertainty and regulations. Forget about being an inspirational leader, he now comes across as a beleaguered, whining who is trying to cover his backside.
Glass wizard,
First of all every president has to inherit problems from previous adm. Did you defend Bush and blast Clinton for the tech bubble/recission? That is part of the reason for tax cuts at the time to help the economy.
I am not saying Bush didn’t leave economic problems but it is 2 years into Obama’s term and he still blaming Bush. I don’t know about you but if I sat for 2 years in my job not getting results and just blaming the previous guy for why the company is not doing well…I wouldn’t be around.
My problem with Obama is he doesn’t have an idea about what to do.
From the WSJ-
Obama hailed yesterdays jobs report as more evidence that “we are headed in the right direction” Really?
Constantly bad mouthing business leaders, talking about taxing businesses and wealthy ect.. is not going to create jobs. You can see that from the job report yesterday, businesses are not going to hire when they don’t know what this President is going to attack next.
I had hoped he would take after Clinton and instead he chose Carter.
G.Wiz,
“…you cannot blame the economy on his administration…”, Incredulity aside, you are saying that Obama and his administration have no culpability for the current state of the economy. If that is so after 2 years in office, then for how long does he remain blameless? One full term? 6 years? How long? Just curious.
Jim – what Brazilian stocks to you anticipate keeping or putting into Jubak’s picks?
Vietnam will be one economy that will pay investors handily. Retail investors can buy into the market through the ETF “VNM”.
“The hole I see in this argument is that developing and developed countries are linked by trade. If developed countries import less, won’t this hurt BRIC economies?”
Developing countries can certainly trade amongst themselves.
Ojunker,
You weren’t paying attention. It was after the tech crash that Greenspan went on his begging spree for everyone to use their houses as ATMs. Clinton and congress are not blameless, they removed the rules that let Greenspan anti-regulatory policy create the debt bubble…Bush just added to the pain with wars he didn’t want to pay for and tax cuts we couldn’t afford.
The best correlation you can make against Obama is that he happens to be from the same city as the free market ideologues (idiots) that got us into this mess in the first place.
There is lots of blame to go around and there are some things you can blame on Obama–promises not kept, for sure. But you cannot blame the economy on his administration without ignoring the facts and making things up as you go, which doesn’t seem to be a problem for some.
Jim, wholeheartedly agree – stock market growth in the developing countries and, IMO, in countries supplying raw materials (AUS, CAN), will outpace gains here and in Europe. There is another (many, of course) factor — namely, the LT economic cycles of the developing world (BIC nay R) reflect the fact that they actually m a n u f a c t u r e products, not just slice and dice an old financial/service economy (EU, US). Yes, actual growth from making things, not merely from “consumer spending”. Anywho, redistribution of wealth from developed to developing economies will continue… and so it goes.
Glasswizard,
The incoming Democratic president Bill Clinton reappointed Greenspan, and kept him as a core member of his economic team.
I would say the hole was dug by Greenspan and the trap was sprung by Clinton, did you forget the tech bubble? And if you are looking for people who blame everyone else you can’t be serious that republicans are any worse than Democrats.
Obama likes to say he will take responsibility for a “problem” then spend the next week blaming everyone else.
levieux:
http://www.mscibarra.com/products/indices/
seems like a good place to start. iShares has a bunch ETFs to mimic these indices.
The hole I see in this argument is that developing and developed countries are linked by trade. If developed countries import less, won’t this hurt BRIC economies?
So, for a debutant like myself, what international indexes should be monitored to determine the appropriate entry points? There seem to be so many.
bsdgv,
I think Jim is saying that the European crisis is likely to keep worried investors in the US market because they think it safer. Probably won’t take long for them to shake it off.
I agree, it doesn’t look good for the lower/middle class at home. The hole dug by Greenspan became the trap sprung by Bush and there doesn’t seem to be a good way out. Business is making the rules and they are fighting for their survival and have little care for collateral damage. Now we rot in the pit or crawl out by stacking the bodies of the less fortunate.
Hey, it’s the conservative way! Everyone with a gun for themselves. It’s a lot easier to be successful when you limit the scope to small, homogeneous groups (the math’s easier) and blame failure on “socialist policy”, aka everyone else.
I’m all in on some Brazil, and not just for the beaches! Have a great holiday!
Is Jim talking decoupling?
> Developed countries have developed and developing countries are still developing.
Exactly… Developing countries have growing pains whereas developed countries have rheumatoid arthritis.
Alright, so to summarize: Developed countries have developed and developing countries are still developing.
It is hard to disagree with Jim’s prognostication that emerging economies will do better than the developed ones. On the other hand, Jim does not explain why American economy “might grow more strongly than the rest of the developed world.” Is Jim counting on the free enterprise sprit of our country? Or the young immigrants who keep America’s average population age lower?
I am sorry but I would like to argue that America will be in worse shape than either Europe or Japan. For the last 60 years, what made American (and perhaps the world) economy great has been the almighty American consumer. We so proudly like to claim that the consumer constitutes 70% of the American economy. And that is the crux of the problem.
1. Americans, like the citizens of other developed countries, are getting old. They are at a disadvantage when we compare their retirement and healthcare benefits to those of the other developed countries and this will put a lot more financial stress on the discretionary dollars.
2. Can Americans and their government help Americans? American consumer and its government is (and will be) swimming in an ocean of personal and public debt. There is almost no savings to fallback on. The savings, if not spent in the 2nd and 3rd gas-guzzling SUV, were blown away in the the stock market crashes of the dotcom and housing bubbles. The main store of value that the Americans have is their houses which is pretty much under water, if not illiquid.
It is fast becoming common wisdom to compare America ’10 to Japan ’90. Well, the Japanese government borrowed the household savings of the Japanese citizens not from the outside. Plus, Japanese government did not have the mandatory expenditures that are assumed when you claim you are the superpower of the world.
So, it seems fair to say while Japan had a lost decade, America’s decade will be a decaying one.
off topic.
TOT CEO: oil to rise to $90 by year end.
http://www.reuters.com/article/idUSTRE65O5TA20100702