It has been a given that where commodities go, so goes emerging markets, however, that correlation seems to have broken down over the last few months. While commodities, both precious and base, have continued to rise, emerging markets have underperformed since November. What gives?
For several years the basic investment thesis is that emerging markets are economic juggernauts with an insatiable demand for the world's natural resources. Their factories devour every form of commodity and transform them into the world’s textiles, steel, clothes, cars, toys, electronics and scores of other exports.
But sometimes you can come up against too much of a good thing. That is what is happening to several of the larger emerging market countries such as China, Brazil and India. All three countries managed to avoid global recession. While we languished with high unemployment and negative growth, most emerging markets continued to grow and grow and grow. As a result, their domestic economies are beginning to overheat.
As they do, their inflation rates are starting to rise to uncomfortable levels with serious consequences for their economic future. China, for example, grew 9.8 percent in the fourth quarter while registering a 4.6 percent inflation rate. This week Brazil announced that consumer prices in their country rose to nearly 6 percent.
The governments of these countries have responded by raising interest rates and tightening credit conditions. The Brazilian Central Bank hiked interest rates by one half percent to 11.25 percent on Thursday and observers expect another hike very soon.
Local investors, drunk on ever-higher stock prices in 2010, are decidedly miffed that their central banks are taking away the punch bowl this year. China's stock market has declined over 15 percent since November. Brazil and India have also underperformed the U.S. markets as well.
In the meantime, commodity prices have largely ignored this new reality until very recently. Brazil's sudden rate hike, in combination with China's higher reading on domestic inflation this week, have finally shaken some of the euphoria out of the commodity market. We need this pullback (and I hope it continues) in order to square prices with reality in the emerging markets
I believe the declines in emerging stock markets are coming to an end. I would be a buyer of those markets on further pullbacks, because I still believe that regardless of any further short-term actions to slow growth, their economies will still outgrow more developed markets this year, next year, and the years after that. Commodities are also a great place to invest once this pullback is over. I advise that you wait for some price stability before adding to positions.
As for the U.S. stock markets, it appears that just about everyone is now in the "too extended, probable sell-off" camp that we have been waiting for over the last few weeks. The contrarian in me doesn't like to see the consensus come over to my point of view because the stock market often does what is most inconvenient to the greatest number of people.
Nonetheless, I would love to see a 3 to 5 percent correction before the end of the month. It would give me the opportunity to put more money to work. For specific recommendations, call or e-mail me.
Bill Schmick is an independent investor with Berkshire Money Management. (See "About" for more information.) None of the information presented in any of these articles is intended to be and should not be construed as an endorsement of BMM or a solicitation to become a client of BMM. The reader should not assume that any strategies, or specific investments discussed are employed, bought, sold or held by BMM. Direct your inquiries to Bill at 1-888-232-6072 (toll free) or e-mail him at wschmick@fairpoint.net. Visit www.afewdollarsmore.com for more of Bill's insights.
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I read you article Commodities feeling a pinch from overseas.
The relevance of the article for me was to add some emerging market investments to my investments upon a pullback, and also to include commodities in my investments as well.
The following question is a little off topic since it is asking about the proportions of emerging market investments and commodities investments in a portfolio.
Question: Do you think the portfolio below is appropriate as a diversified portfolio (to include emerging market and commodity
investments) for one about to retire? I know bonds are usually supposed to be about the same as the age of the individual (I am 59), however, with interest rates so low, the value of the bond is bound to loose its value as interest rates rise.
The above portfolio would be needed for about 50% of retirement income and the other 50% would come from fixed pension and two social security incomes (myself and spouse). Could BRK-B and the pension and SocSec serve as the bond portion of the portfolio?
A response would be appreciated. Your response my also be interesting to your column readers.
Dear Rick,
Thanks for your question. Let me address your first point on the question of your bond allocation. I don't believe in allocating money into an asset class simply because some theorists say that is what you are supposed to do. Likewise, I reject the rule of thumb that you should have about the same percentage allocation in bonds as your age (in your case, 59)
Those kind of hair-brained attitudes of the investment community have caused untold damage to the savings of the individual investor.
Fortunately your common sense concern that "the value of the bond is bound to loose its value as interest rates rise" is not only correct but the main reason why you should not be investing in bonds, or at least in U.S. Treasury and municipal bonds.
Certain bonds will still prosper, at least initially, as interest rates rise. Investment grade corporate bonds as well as high yielding "junk" bonds do well.
The answer to your next question re: 1) your allocation in commodities and emerging markets appropriate for one about to retire and 2) can BRK.B act as a bond-like allocation (because of its conservative nature) along with your social security and fixed pension.
BRK.b is a stock and in no way can it replace a bond. In order to answer whether your pension fund can act as a bond replacement I would need to know how much of your pension is invested in bonds. Normally pension funds are invested conservatively with a large percentage of its holdings invested in bonds so you may have a large component of your overall portfolio already invested in fixed income.
However, you must also recognize that there is no portfolio that is appropriate right now for long-term investment. A Buy and Hold strategy won't cut it, at least for the next several years. I believe that the markets are poised for some substantial gains over the next 6-9 months. Ask me again in August and I may have a completely different view. You see, we are in a cyclical bull market right now, (a short-term rally), which will soon give way to the resumption of the long-term bear market. As such, my allocation might be 70% bonds and 30% cash by sometime late this summer.
I hope that answers your question. Unfortunately, we can't allow our portfolios to run on auto-pilot anymore. There will be periods where a lot of money can be made and then even more money lost unless you actively manage your investments.
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