August 29, 2003

Getting Outside the Dollar

It was odd that U.S. government bonds rallied yesterday on the kind of news that usually leads to selling. Strong GDP growth usually causes selling in Treasuries. In a growing economy, investors would rather own stocks or higher yielding emerging market debt. Of course, maybe investors are on to the fact that this isn’t your garden-variety recovery. Either way, the 10-year note was up 23/32 point, and its yield fell to 4.428% from 4.521%. The 30-year bond was up 1 1/32 points and its yield moved down from 5.297% to 5.227%. My options service subscribers may own calls on TLT, Lehman’s 20-year bond index fund. TLT was up 1% yesterday, although in the interests of full disclosure I should point out that so far the calls I selected are up only about 3% from our August 11th, entry price. Still, not bad, making a little money on bond calls during a bond bear market. Buying calls on a bond index isn’t something your average investor could have done even 5 years ago. In fact, the entire fixed income market was sort of a private investment preserve, only accessible to high net-worth investors who were moving around big chunks of a sizable portfolio. But not anymore. Now trading or investing in the bond market is as easy as buying or selling a stock through Ameritrade. Everyone can be a bond vigilante. (More on this later today when I look in depth at how to “Make Uncle Sam Pay.”) The only kind of bond trading still off-limits to retail investors is junk bond investing (or investing in high-yielding bonds). You can, as I’ve mentioned here, buy corporate bonds through LQD, another bond ETF that allows you to go “short” or “long” corporate debt easily. But so far, there’s no equivalent ETF for emerging market debt, which, while not always junk, is typically higher risk/higher yield. In fact, it wasn’t even until April of this year that you could invest in emerging markets through a PGI. Prior to that, you had to take your chances in a mutual fund (higher fees), or look for particular American Depository Receipts. I’ve recently added the iShares Emerging Market Index Fund (EEM) to the SI portfolio. It’s not exactly emerging market debt. But it’s about as close as you’re going to get and still be able to buy it and sell it like a stock. Options don’t trade on EEM yet, unfortunately. I think it’s just a matter of time, though. Meanwhile, EEM's top tend holdings are: 1. Samsung Electronics 5.99% 2. Angle American 4.09% 3. Telefonos de Mexico 2.28% 4. China Mobile 1.98% 5. Teva Pharmaceutical Industries 1.97% 6. Taiwan Semiconductor 1.85% 7. Lukoil Holding 1.43% 8. Kookmin Bank 1.34% 9. Posco 1.31% 10. Sasol 1.28% Are there some stocks among those top ten I wouldn’t buy on their own? Sure. In fact, I’m bearish on the whole semiconductor sector. It’s highly unlikely I’d own Taiwan semiconductor. On the other hand, I’m already long Sasol in the SI portfolio. I get two main benefits from EEM. First, I can invest specifically in the idea that investors will look outside the U.S. for better growth opportunities. Second, I get some diversification, geographically and across sectors with EEM. Seems contradictory, specification WITH diversification. But it’s true. And so far, EEM is up about 10% from our entry price. Of course, the premise of the whole idea is that investors are tiring of buying the same old former bull market leaders and the same old tired U.S. bonds. The proof, it seems to me, is already rolling in. And EEM is relatively new. The higher profile it comes, the more popular I believe it will become. A NEW WAY TO INVEST IN EMERGING MARKETS WITH LESS RISK Today’s Wall Street Journal reported that “investors have bid emerging-markets bonds to their strongest level in five years.” The article goes on to caution that, “the supply-demand situation could shift against emerging-markets issuers” and that “Emerging-markets nations may soon find themselves in stronger competition to borrow internationally with the U.S. government.” Competition indeed. The tone of the article seems to suggest that if investors are forced to choose between buying an ever-increasing supply of U.S. debt and emerging market debt, they’ll choose U.S. debt. Well…it HAS been true for the last 10 years. But as I showed yesterday, the world’s voracious appetite for U.S. debt may be diminishing…primarily because the U.S. government projects nothing but greater and greater deficits for the next 10 years. It really comes down to whether you believe investors will continue demanding U.S. bonds, no matter how large the deficit gets. Vincent Truglia, co-manager of Moody's Investors Services' sovereign risk unit, said in the Journal article that "A large [budget] deficit, keeping everything else equal, means the U.S. will be the largest drawer upon world savings," making less money available for emerging-market countries, he said.” Maybe. But only if the world keeps lending its savings to a belligerent American government that’s financing its war machine with the export-driven profits of emerging market countries. And THAT is an issue which deserves a much fuller treatment, which I’ll get to later this afternoon. For now, beware bonds.


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