To My Friends and Clients:
Here is an economics quiz. The relevance of this quiz to your financial situation will be explained below:
1. Who is the world’s largest exporter? Japan, China, the US or Germany?
2. Who have been the largest purchasers of US Treasury bonds in 2004? US investors, the US Government, Europeans, or Asians?
3. What country in 2004 went from being an oil exporter to a net importer? The US, Canada, China, or India?
4. What country enjoyed record trade surpluses for the last two years? (In other words, exported more than imported, sold more than bought.) China, India, Brazil, or the US?
1. Germany has been the world’s largest exporter since 2002.
2. Asian governments and Japanese investors were the largest purchasers of US Treasury bonds in 2004. There was a very large increase in foreign purchases in the last few months of 2004, and this is considered to be a reason long-term interest rates did not rise as expected.
3. China now consumes more oil than it can produce, and the anticipated increase in demand by China and India is a reason oil prices are predicted to remain in a much higher range than previously expected.
4. Brazil has enjoyed record trade surpluses these last few years and its economy appears poised for continued growth and stability.
The relevance of all this is that countries and events all over the world affect us in ways we cannot begin to appreciate. The share prices of companies such as Caterpillar, Johnson & Johnson, and Starbucks, for example, may be influenced as much or more by foreign sales than domestic sales. Are companies such as Honda and Toyota foreign (Japanese) or domestic (because of their US factories)? We have worried that our dependence on foreign oil makes us vulnerable, but how many understand the impact of foreign ownership of US bonds and US currency?
As always, I have no way to predict whether the stock or bond markets will be up or down by the end of 2005. We worked hard in 2004 to align your investment strategies to your goals and your tolerance for fluctuation. We began to diversify more into international investments and, for some, into alternative investments such as gold, natural resources, real estate, commodities and futures contracts. I have come to the conclusion that every investor would benefit from greater such diversification.
In the past there have been times when foreign markets have delivered better investment returns than US markets, and then have these results reversed in later years. This easily could happen again, making it seem that 2005 was not the “right” time to begin or expand this kind of approach. However, I believe we are at the beginning of a major shift in the economic and investment worlds.
The dollar’s decline against the euro makes it easier for Europeans to buy US companies and properties. The increased demand from Asia for raw materials, finished goods, services and technologies creates the potential for good (new and/or expanded markets for US companies) and bad (inflation as too much demand chases too few resources). Most of all the health of the US economy is jeopardized by the size and likely duration of the US budget deficit, and by the failure of the government and voters to recognize the importance of investing in things such as education, infrastructure (roads and bridges), public safety, health care systems, communications systems, alternative fuel sources and the environment. (Perhaps our business and political leaders should re-read the Aesop story of the grasshopper and the ant!) I do not believe these are short-term trends. While the US is likely to remain the world’s leading military and economic power, it is also probable that other countries and regions will prosper and create new investment opportunities.
For these reasons I feel international and alternative markets should represent anywhere from 10% to 50% of one’s entire investment program. I remain convinced US bonds are not a prudent place to be at this time. The exception might be tax-exempt bonds (not bond funds!) maturing in 2 to 8 years for families needing income. If and when long-term rates finally rise, I expect to begin recommending a higher percentage of portfolios in bonds than I have in the past. This could occur later this year or at some point in 2006. Again, the extent to which your portfolio includes bonds will depend upon your situation and the strategies we develop together.
These adjusted portfolios will probably not deliver higher returns in any one year. In fact, when the US market soars, more diversified accounts might “under-perform.” The goal of this broader allocation is to provide competitive and more level returns over the long-term. In addition, while any one additional asset class might itself be quite volatile, studies have shown that including a variety of investment classes can actually reduce portfolio volatility – which should make the ride less nervous.
Also remember that every individual has different needs, goals and concerns. Your investment strategies are designed to reflect your unique perspective. Some of you will be more aggressive than the average, some less so. Some of you will want to avoid international or alternative investing, others will embrace it and I may need to work with you to hold you back. Our responsibility remains helping you stay focused on your goals, and to be certain the strategies we are using are consistent with these goals, needs and concerns.
As always, try to focus on the long term. It is very important not to be distracted by the noise of short-term fluctuations and the opinions of all the “experts.” Please be sure to let us know if you have questions about your financial or investment situation, or if you would like to schedule an appointment.
Thank you again for the opportunity to work with you.
Best wishes for 2005 – and beyond!
Robert K. Haley, JD, CFP®, CLTC