Related topics: stocks, emerging markets, Brazil, China, Jim Jubak
Hope you like challenges.
For months I've argued that the United States would have the best-performing stock market in the world for the first half of 2011. But I've added that investors shouldn't get too comfortable with their portfolio allocations, because the second half of 2011 looked much rockier for the U.S. and other developed stock markets. Sometime in the spring, I said, investors would want to start shifting the weighting in their portfolios to add more exposure to emerging stock markets.
And in my April 7 column, about how global risk is shifting, I wrote that I thought the time had arrived to start making that re-allocation in investors' portfolios.
I call this challenge No. 1. It's not easy to go through an existing portfolio, cull the stocks that you want to sell to create cash for new investments, and then pick new stocks that you'd like to overweight.
Remember Challenge No. 2?
The global economy has not stood still while investors enjoyed profits from the U.S. stock market and got ready to shift portfolios toward emerging stock markets. Way back in January, I wrote in a column called "How to invest in a zigzag economy" that the U.S. economy was in the early recovery stage of the economic cycle. Developing economies were further along -- maybe making a transition from the early recovery to the late recovery.
Jim Jubak
Now, three months later, I think the U.S. economy and the global economy have both moved further along in the economic cycle. And that should change the kinds of stocks you cull from your U.S. portfolio and the kinds of stocks you add to your weightings of emerging market stocks.
Adding to your positions in emerging markets right now doesn't mean going back to the commodity-heavy picks of earlier in the global cycle. If you're going to overweight Brazil, for example, that doesn't mean just loading up on iron miner Vale (VALE, news) and oil producer Petrobras (PBR, news).
Let me try to explain what meeting challenges No. 1 and No. 2 does mean right now.
Back in January, I laid out Sam Stovall's scheme for the stages of the economic cycle. (I think his 1996 book "Sector Investing" is still the best resource on the subject.)
Stovall divides the economic cycle into four stages:
- Early recession. You should remember this stage vividly. Consumer sentiment ranges from fear to terror, industrial production plunges, interest rates peak and then start to fall, and unemployment begins to rise rapidly. Sectors that have done well -- relatively, at least -- during this stage include services (near the beginning), utilities and (near the end of the stage) cyclicals and transports.
- Full recession. Gross domestic product tumbles, interest rates keep falling, and unemployment rises. Sectors that do best during this stage, historically, have been cyclicals and transports (at the beginning of the stage), technology and (near the end) industrials.
- Early recovery. Consumer sentiment improves, industrial production turns up, interest rates hit bottom and unemployment peaks and starts to move lower. Sectors that do best are usually industrials (near the beginning of the stage), basic materials and (near the end) energy.
- Late recovery. Interest rates rise as the central bank tries to control inflation, consumer sentiment heads down and industrial production is flat. Sectors that have done well in this stage include energy and (near the end of the stage) consumer staples and services.
In January I argued that the U.S. economy was in the early recovery stage, so your U.S. portfolio should overweight industrials, basic materials and, gradually, energy stocks. Emerging markets were further along toward the late recovery stage. Central banks in those countries had already started to raise interest rates, for example. Now that the European Central Bank has raised interest rates and the Federal Reserve looks likely to do so at the end of 2011 or in early 2012, I'd argue that developed economies are on the road to late recovery.
A closer look at emerging markets
It's always dangerous to apply an economic model developed for the economies of the developed world to the emerging economies of Brazil, China or India. Growth rates are higher in those developing economies, for one thing, and that means that, even in a late recovery stage, industrial production is likely to be growing.
But correcting for some of those differences as well as we can, I think it is accurate to say that, in a late recovery stage, industrials and basic material sectors in developing economies have recovered off the bottom and seen their biggest surge in growth. For example, in March, passenger vehicle sales in China increased just 6.5% from March 2010. I say "just" because auto sales grew by 63% in March 2010 over the prior year. Annual auto sales are now forecast to grow by 10% to 15% in China in 2011. That's certainly solid growth, but it's not the 32% annual growth the market saw in 2010.
You can see the same pattern in material stocks. Copper, for example, is in a price decline that's expected to last until the middle of 2011 before commencing a recovery that will take prices up 17% by the end of the year from the end of 2010. Copper demand is projected to grow by about 6% this year. There's nothing wrong with any of those numbers, but that's not the jump in demand or price that you get in a commodity that's coming off the bottom. In 2009, copper prices climbed about 120%, for example. In the late recovery stage, I think investors are looking at solid gains from material stocks in emerging markets, but not of the dimensions for 2009 and 2010.
