As we all have probably heard by now, insurgents in Iraq have seized many of the oil-rich country’s major cities such as Fallujah, Tikrit, Mosul, and Kirkuk, bringing the country to the brink of what could be civil war. Heading into the weekend, all eyes will be on whether or not Baghdad becomes the next battleground for ISIS (Islamic State in Iraq and Syria) and sectarian fighters such as the Kurds, and whether or not President Obama commits American resources to the fight. Politics and beliefs aside, the deteriorating situation in Iraq has the potential to impact global financial markets, most immediately the oil market.
Iraq is the second largest oil-producing member of OPEC (Organization for the Petroleum Exporting Countries) next to Saudi Arabia, pumping out more than 3.3 million barrels of oil per day. This week alone, fears of Iraqi supply coming off-line sent oil prices to nine-month highs. West Texas Intermediate crude oil (WTI) rose +4.13% this week to close at $106.91/bbl, its highest level since September 2013. Even as domestic oil production remains near all-time highs, global supply has shrunk in recent months with events in Libya, Nigeria, and now Iraq taking supply off-line, making this week’s events even more important for the global oil market.
The events in Iraq are exactly what the market doesn’t need. With trading volumes near decade lows, volatility near historic lows, and equity valuations looking fairly valued to slightly overvalued, a worsening situation in Iraq could be just the event traders have been looking for to sell stock and send the market lower. For now, we wait and see what events unfold over the weekend, and hope there isn’t a meaningful spillover into global equity markets.
Quick – U.S. stocks account for what percentage of global equities?
Try just 49%.
Market participants ranging all the way from financial professionals to do-it-yourself portfolio managers are often surprised to learn that U.S. stocks actually make up less than half of all global equities. Examining the MSCI All-Country World Index (or MSCI ACWI), U.S. stocks currently account for just 49% of global equities:
Unbeknownst to them, investors often suffer from something called home country bias, or the tendency to unjustifiably favor the investment options located in one’s home market. Why? Investors usually invest in what they know and domestic equities tend to be what they are most familiar with. Think about it – an average nightly newscast in the U.S. will likely recap the day’s performance of the S&P 500, Dow Jones Industrial Average, and NASDAQ, but international equities usually get no mention at all. Because of this, unless an individual is an ardent reader of The Wall Street Journal, it is likely that companies like Roche Holding AG, Total SA, Taiwan Semiconductor Manufacturing, and America Movil SAB de CV sound just a little bit foreign (pun intended). In actuality, these are huge multi-billion dollar companies, on par with several U.S. household names!
Why is this an issue? While not intentional on the part of investors, the behavioral tendency to focus predominantly on domestic investments effectively limits one’s opportunity set. The result is a subpar portfolio that fails to harness the dynamic nature of the global economy. The world is an expansive place and broadening one’s worldview to stretch outside the United States offers the chance to access a more diverse set of opportunities.
For example, the IMF tracks growth rates for various countries around the world and a quick look at the map below reveals that investors focused primarily on the U.S. are missing out on some truly awesome growth stories abroad. It is not hard to imagine some of these countries growing at upwards of 6-10% becoming the economic stars of tomorrow. These high growth countries are often classified as emerging or frontier markets and fortunately for the internationally-challenged investor, these same high growth opportunities are getting easier to incorporate into existing portfolios through the use of exchange-traded funds.
However, from an investor’s viewpoint, economic growth only tells part of the story. It is entirely possibly that a country could grow at a seemingly impressive clip, but nonetheless fail to live up to investors’ expectations. Likewise, a country can post just tepid growth, but still manage to surpass investors’ expectations. Take last year, for example – the U.S. economy grew at a lukewarm +2.6%, but it exceeded expectations, driving the S&P 500 up +32.4%. At the same time, China’s economy grew at a scorching +7.7%, but it fell short of expectations, driving the Shanghai Stock Exchange Composite down -1.0%. Clearly, economic growth is only part of the story. It is also important to consider the actual performance of the stock markets within these countries. After all, it is that performance that ultimately impacts an individual’s portfolio.
Below is a table highlighting performance returns for various countries/regions over the last nine years:
The table highlights a few things. First, there are certainly diversification benefits associated with a more global approach to equity investing. Equities from around the world don’t all move in the same direction and at the same intensity; when some are in the green, others are in the red, and vice versa. When some are up a lot, others are up just a little. For example, the years coming out of 2008’s financial crisis have been particularly kind to U.S. equities, however, international equities were the place to be in the years preceding the crisis. The best and worst performing regions aren’t persistent – they change from period to period.
This is true because equities from different parts of the world are driven by different factors (growth rates, government policy, currency levels, valuations, economic activity, etc.). As a result, the different regions of the world are not perfectly correlated with one another.
By taking a global worldview and adopting a portfolio with multiple geographic exposures, an investor limits their exposure to any one area, while also ensuring that they always have at least some exposure to the countries and regions currently in favor. The end result is a smoother ride over time. A global worldview is a key part of our process here at Nottingham; we are constantly performing fundamental research on various regions, looking for the chance to invest in growth opportunities likely to exceed current expectations.
Remember, when it comes to investing, the world is your oyster.
Until Next Time,
Chris Hugar, CFA
Check out our new article in today’s (05/23) issue of Buffalo Business First. The article “Smart Money: Applying an Institutional Approach to Your Portfolio” is located on page 22 and it explores how institutional investors use indexing to achieve their goals and the importance that these investors place on asset allocation as the key determinant of investing success.
Click here to read the full article Nottingham-Business First Article
This morning the Department of Labor announced that the U.S. economy added +288k non-farm payrolls in April, ahead of expectations for additions of +218k. Additionally, March figures were revised upward by +11k, from +192k to +203k. Monthly payrolls have now increased every month so far in 2014, bringing the 6-month moving average of jobs added to +198k per month. This month’s additions brought the headline unemployment rate down to 6.3% (from 6.7% last month), and the underemployment rate down to 12.3% (from 12.8% last month). While on the surface the jobs number looked quite robust, the internal fundamentals again remained weak, with average hours worked per week flat at 34.5, and wage growth flat M/M and +1.9% Y/Y. Furthermore, the labor force participation rate dropped -0.4% to 62.8%, with a whopping -806k people exiting the labor force.
Equity markets seemed unfazed by the number, with the S&P 500 barely budging on the news, signaling that either a strong jobs number was expected, the underlying fundamentals were indeed weak – or a combination of both. It is likely that the overall health of the labor market is weaker than the 6.3% unemployment rate would lead one to believe. The labor force participation rate remains at historically depressed levels, the economy continues to add low-quality jobs (i.e. temporary workers and leisure/hospitality jobs), average hours worked has yet to rise, and wage growth is barely keeping up with inflation.
The U.S. economy is recovering – slowly – and today’s jobs number doesn’t change our views.