Emerging Market Asset Allocation
It would be unthinkable to put together an investment portfolio today that did not include Apple, Amazon, Microsoft, and Alphabet. Perhaps also Facebook, Tesla, and Netflix. These companies have become very powerful through domination of at least one critical niche in the new economy, plus they are constantly pushing the frontiers of innovation. There are also foreign companies for which the same can be said, yet more American investors and advisors do not take the same care to ensure that they have them in their portfolios. The two most important companies in the world today just might be Taiwan Semiconductor and the Netherland’s ASML Holdings, as they each have control of a part of the most critical aspect of modern society – high end semiconductors. Moreover, if one wanted to ensure they were exposed to the largest consumer markets in the world, how could one not own China’s Tencent and Alibaba, India’s HDFC Bank, and MercadoLibre – Latin America’s ecommerce giant?
I am looking at our portfolios now to ensure not just that we have enough emerging market exposure but also that we haven’t inadvertently missed out on any of these innovative firms. This is where the growth in this very slowly growing global economy is coming from. It should certainly be understood that any and all of these companies will have challenges from time to time, be they from a strengthening dollar or some kind of conflict in their home country. The important thing is that many American investors are becoming discerning enough to know that 1) you don’t sell ALL emerging market positions because India is quarreling with Pakistan or because China is quarrelling with the U.S.; and 2) like it or not, the 4.3% of the earth’s population that the United States of America represents is not going to dominate the 21st century as it dominated the 20th, no matter what we do. To be clear, doubling your EM weighting might not pay off over the next 12 or 24 months. Rather, this is a strategic asset allocation decision grounded in the belief that EM economies, and their component companies, are poised for a strong decade.
Bonds and Inflation
We’ve witnessed a minor upturn in inflationary expectations in January, which is nothing unusual this time of year. The benchmark bond index dropped -0.86% for the month (which was still better than the S&P 500’s -1.02%, it should be noted). I am not worried about bonds because I expect a fairly disappointing economic environment for most of the year relative to what markets were pricing in late last year after the vaccines were discovered. I’m not going to get negative on bonds until we see a bounce in the measures of the velocity of money.
Let Your Winners Run
In a recent Barron’s, James Anderson makes reference to a recent study done by Hendrik Bessembinder of Arizona State which basically states that most companies’ stocks do not outperform T-bills[i]. By far the largest stock gains come from a surprisingly small number of companies that are able to compound wealth over long periods. Anderson believes the message from this study, which looked at 62,000 companies worldwide from 1990 to 2018, to be that one should be very careful not to sell great companies too soon because they are few and far between percentagewise.
Active vs. Passive
In the active vs. passive debate, one active argument that almost never gets made is this: Active managers rarely do truly idiotic things. What do I mean by this? The iShares Russell 2000 ETF (IWM) owns GameStop (GME) because it is a small cap stock and owning it is what it is supposed to do. IWM does not apply any type of profitability filter unlike the Vanguard Small Cap ETF (VB) which does. Last month, as GME’s price soared, so did IWM’s. Much faster than did VB’s. Therefore, uninformed investor money tended to flow in late January to IWM, which was forced to invest it in more and more shares of GME as its price rose. When one invests in IWM, one may believe that they are receiving a fraction of a percent of hundreds of different small companies, because that is usually true. If you bought it on January 25th, however, you were unwittingly taking a flier on GME, which was at that point over 8% of the portfolio, and in other sub-Reddit champions such as Macy’s and Bed, Bath & Beyond. There are several other ETFs where this phenomenon was even more egregious, such as the Cambria Shareholder Yield ETF, which had a lot more GME to start with, so its weighting got to well over 10%. That is being unwound in a hurry today. The point is that you should be careful to know your passive investment products, because a “buy-anything-in-this-capitalization-range” policy can bite you if you are not careful.
Oh, and by the way, this type of speculative behavior is just never seen at or around stock market bottoms. Just sayin’.
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