Look to the World for Improved Performance and Diversification

By on May 10, 2006

Originally published on:

October 6, 1996

The market is due for another pull back as the Dow approaches 6,000. It won’t be anything serious, maybe a drop to 5700-5800. Then it should continue on it’s upward path. Many pundits are underestimating the power of monthly allotments that millions of people have going into the market. This will almost always provide more purchases than sales of stock on a monthly basis for the next 10 years. Around 2005, the first of the baby boom generation begin retiring and making net withdrawals from the market. It’s a simple fact that prices go up when supply exceeds demand and this is going to be the case for the foreseeable future. This doesn’t mean that we’ll avoid the sharp corrections like the one we experienced in July. I just don’t feel that a bear market where stocks drop 20-40% is in the offing.

I seriously doubt that the economy will show enough strength to raise long term interest rates significantly in the next year. The consumer is pretty well tapped out. We also are experiencing a widening gap between the rich and poor which is dampening demand for high ticket items. The only problem I foresee will be sustaining the earnings growth necessary to justify a somewhat overvalued market.

Editor’s note: The newsletter will be published every other Sunday, instead of every other Friday.

Look to the World for Improved Performance and Diversification

The two “real world” portfolios have a fairly large proportion of their assets in foreign equities. This might sound contradictory to the general message of this newsletter that domestic equities will be a good place to invest in over the next 10 years. Granted, there are additional risks when investing outside the U.S. There is currency risk in an unhedged portfolio of foreign stocks or funds. There is also political risk which varies widely from country to country. However, these risks are minimal if you have a widely diversified portfolio of both US and foreign stocks. If the dollar strengthens the value of foreign stocks decline, however, there is a mitigating effect. The U.S. economy is so big and pervasive that most foreign companies do a good part of their business with us. As the dollar goes up foreign companies are able to charge less for their products and make the same profit per unit sold. Thus their earnings are impacted positively by a stronger dollar and their stock prices should rise, somewhat counteracting the depreciation of the local currency.

European companies are in a similar situation as the U.S. was in the early 80’s. Unemployment is high, growth is anemic and many companies have the potential to restructure their operations and increase profits. Valuations of stocks in Europe are generally very favorable when compared to U.S. equities. 30% of the aggressive portfolio’s assets are in European equities. I expect them to outperform U.S. stocks for the next few years.

The Master Marketer

I was reading Business Week the other day and an ad caught my eye. The full page ad has a very large number “1” towards the center of the page in what appears to be one of those computer screen buttons. In front of the 1, also in large, though slightly smaller, bold letters it reads “Rated NO.” In another button it reads “$29.95 Trade”. Below the two large buttons in substantially smaller print it reads “Schwab is #1 in automation. Smart Money July 1996″. The ad is for Charles Schwab’s e.schwab service, his electronic brokerage subsidiary. Of course, the automation category is just one of several that Smart Money uses to rate discount brokerages. Schwab conveniently leaves this information out.

Schwab has done a great job marketing his brokerage, but his commissions are a joke. $29.95 isn’t so bad, although you can do much, much better if you shop around for brokerages offering electronic trading. His charges for regular phone orders are downright usurious for a discount broker. I wouldn’t even call him a discounter anymore, but I guess he can claim it when people allow themselves to be scalped by the full service brokers. You have to charge high prices to be able to dream up and publish these kind of misleading ads.

Recommended Allocations

The aggressive portfolio is invested in 90% stocks, 10% cash. The conservative portfolio currently is 70% stocks, 30% cash.

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