The stock market fell on Wednesday on news that the World Bank revised its global growth estimate downward for 2014 from 3.2 percent to 2.8 percent. While the S&P 500 was down a modest 0.4 percent, investors have become used to an ever-rising market making this a newsworthy event. However, in the broader scheme of things, stocks barely moved.
Despite the fact that investors expressed concern over the World Bank’s revisions, the writing has been on the wall for some time. We can parrot the World Bank’s reasons here—cool weather in the United States during the first quarter and trouble in the Ukraine. But if you look closely at the revision, the bulk of the downgrade came out of developing economies. While Russia and the Ukraine are developing economies, they don’t make up a large portion of this class of countries, which includes China, Brazil, Mexico, Chile, Ghana, among several other countries. Emerging market stocks performed more or less in-line with American stocks if we compare the S&P 500 to the iShares Emerging Market ETF (NYSEARCA:EEM), both of which have risen about 5 percent for the year.
The simple fact of the matter is that these countries are seeing slower growth because they are exporting less, and they are exporting less because developed countries are consuming less. Emerging market economic growth is largely dependent upon their exports to developed countries such as the United States, and their central banks keep their currencies weak in order to make them more appealing trading partners for developing nations. But as developed nations consume less—as they have too much debt—they import less from the developing nations, which in turn slows down their economies. Meanwhile the developed nations’ economies don’t decelerate, or they don’t decelerate as much because the difference is made up for by central bankers and politicians.
This, in a nutshell, is why the global economy is slowing, and these headwinds will put pressure on global economic growth until the developed economies deleverage and start to grow their economies on a solid foundation of manufacturing and production rather than debt creation and services.
With this basic outlook, we can come up with a few investment strategies that should succeed in this kind of environment.
1. Buy emerging market currencies
Eventually emerging market country leaders will realize that competing to devalue their currencies isn’t worthwhile. They do so in order to entice foreigners to buy their products, but actually if these nations had strong currencies the locals could easily afford these products. We are already seeing countries such as Turkey and Russia shore up their currencies, and I suspect that this will continue. There are many ways for investors to get exposure to emerging market currencies. For instance there is the WisdomTree Dreyfus Emerging Currency ETF (NYSEARCA:CEW), which is up 2.25 percent this year.
Investors looking for something more specific can buy the WisdomTree Dreyfus Brazilian Real Fund (NYSEARCA:BZF), which is up 10 percent for the year, or the WisdomTree Dreyfus Chinese Yuan Fund (CYB), which is down 1.6 percent for the year but which appears to have made a double bottom. You also may want to check with your broker to see if you can buy CDs in specific emerging market currencies, as this will enable you to collect interest in addition to getting currency exposure.
2. Sell overvalued cyclical stocks
This may sound a little vague, but basically if you own a cyclical stock (i.e. a stock that needs a strong economy to perform well) and it is trading at a P/E multiple that assumes growth—say at least 18 times earnings—then it is probably too risky to own in this environment. I’m not the only one who holds this sentiment. Stocks that fit this description such as Boeing (NYSE:BA) and Federal Express (NYSE:FDX) underperformed the market today. Inexpensive non-cyclical stocks such as Exxon Mobil (NYSE:XOM) were up because these are the sorts of companies that can maintain their earnings power in a weak economic environment.
3. Buy Treasuries, but only for a trade
When people are scared, they run to Treasury Bonds even if the fundamentals are deteriorating. Of course, as the global economy weakens, this means that U. S government tax revenues decline while the total debt load climbs, and this is bad for Treasuries fundamentally. But for some reason Treasuries are considered to be safe and they attract investors when they sell stocks. While Treasuries might rise in the short term, I am concerned that investors will eventually figure out that they are a losing bet and so I think the initial pop should be sold.
4. Buy gold
When investors feel that they can’t own Treasuries or stocks, many will turn to gold. Gold retains its value over long periods of time. While government issued currencies have come and gone, gold has been around for as long as civilization. This fact will attract investors when they simply give up on other assets.
You can buy gold coins, or if you want something in a brokerage account consider the Sprott Physical Gold Trust (NYSEARCA:PHYS), which has superior tax treatment to the SPDR Gold Trust (NYSEARCA:GLD), which is taxed as a collectible at 28 percent. You should not buy miners unless you have a deep understanding of the industry.
Disclosure: Ben Kramer-Miller is long Exxon Mobil. He owns gold coins and shares in select gold mining companies.