Archive for November, 2010

Nice Guys Finish Last

I spent much of this past week travelling around some of my old haunts in Central Europe. One night, I popped into a bar and I saw a group of three bulky, ominous-looking figures sitting in the back. It was a scene straight out of the Godfather, with three Don Corleone-like figures smoking fat cigars, throwing back shots of whiskey, celebrating a business deal that they had consummated that day. As I ambled closer to take in the scene, I suddenly recognized one of them. He had been a junior colleague at an investment bank I had worked at about 15 years ago, and later an analyst at a U.S. hedge fund that had blown up after the Russian market meltdown in 1998. Over that time period, he had fashioned himself into something very different from an aspiring Wall Street analyst. He told me that he had retired in his mid-30s and now spent his time doing deals in the Balkans and Uzbekistan. Whatever he was doing, it was clear he had not accumulated his fortune by diligently investing 10% of his monthly salary into an S&P 500 Index Fund.

“My friend, do you trust me?”

Fast forward to last night in London, where a Goldman Sachs analyst and I chatted with Harvard President Drew Faust about the challenges of teaching business ethics to future derivatives traders at the Harvard Business School. I was struck, yet again, by the U.S.-style idealism of trying to shoehorn a lifetime’s worth of ethical behavior into a semester-long business course. I can almost imagine the derisive roar of laughter I’d hear from the table of East European Don Corleones as I’d relate Harvard’s idealistic aspirations to them.

In the United States, we like to think that if you play by the rules, you get rewarded for your efforts. So I decided to investigate whether investing in countries that broadly adhere to U.S.-style ethics offer a better return to investors than their less “ethically correct” counterparts. My conclusions may surprise — and perhaps even disturb — you.

Trust: The Invisible Lubricant

Francis Fukuyama first wrote about the importance of ethical behavior in his book “Trust: The Social Virtues and The Creation of Prosperity,” in which he defined “trust” broadly as honest, and cooperative behaviour, based on commonly shared norms among members of a community. “Trust” is the invisible lubricant that greases all business interactions.

Fukuyama divides societies in the world into two groups on the basis of “trust.” Fukuyama argues that China, France, Korea and Italy are “low-trust” societies, whereas Japan, Germany and the United States are “high trust.” Only “high-trust” societies permit the development of modern capitalist structures, like multinationals and global stock exchanges. Low-trust cultures rely more on the extended family to build commercial, social and political networks. As a result, companies in a low-trust society are either small, family-run ventures or very large, state-operated and, therefore, generally corrupt.

You can argue with the accuracy of Fukuyama’s sweeping generalizations. But if you’ve travelled outside the United States, you know what a pain life can be in “low-trust” societies. For all of the flack it has taken recently, the United States is a “high-trust” society. Yes, we have corrupt mortgage brokers and Bernie Madoff. But in most social daily interactions — paying for a cab, picking up a tab at a restaurant or buying gas for your car — you can be pretty sure that you’re not going to get ripped off. But try doing those three things in the Ukraine, and you’ll quickly find that things don’t quite work out that way.

Investing in “High-Trust” Markets

Intuitively, you’d think that the “high-trust” societies would make for the best investments. As a surrogate, I looked at the 2010 Corruption Perceptions Index of Transparency International. The top 10 ranking countries this year were Denmark, New Zealand, Singapore, Finland, Sweden, Canada, Netherlands, Austria, Switzerland and Norway.

The list has substantial overlap with the World Economic Forum’s report on the world’s most competitive economies. The top 10 countries in the competitiveness report consist of Switzerland, Sweden, Singapore, the United States, Germany, Japan, Finland, Netherlands, Denmark and Canada.

For good measure, I threw in the UN Human Development Index, and the list again is familiar: The top 10 consists of Norway, Australia, New Zealand, United States, Ireland, Liechtenstein, Netherlands, Canada, Sweden and Germany.

It seems that if you restrict your investments to those approximating “high-trust” markets, you’d limit yourself to Northern Europe, the German-speaking countries, the United States, Australia and New Zealand, with Japan and Singapore thrown in.

You’d also completely leave out the countries that had the top-performing stock markets of the past decade…

“Low-Trust” Markets Rule

Three of the top-performing markets in the world in 2010 — Thailand, Indonesia and Colombia — are also among the most corrupt, according to Transparency International. The highest ranking BRIC country is Brazil — at an unimpressive number, 69. China ranked 78, India finished 87 and Russia fell near the bottom at 154.

Fukuyama does not predict lasting success for China, as a “low-trust” society. And, indeed, trust is a huge issue with investing in China. U.S.-listed Chinese small-cap stocks trade at a deep discount to their Western peers, as more of them continue to be rocked by accounting scandals. Even if investors in Internet portal Baidu (BIDU) are making a mint in the stock this year, the company itself faces a huge obstacle to become a global brand. Why? People don’t trust it because of its collusion with the Chinese government.

At the same time, the consensus is that the size of China’s stock market will overtake that of the United States within the next two decades… Go figure…

As Americans, we’d like to think that countries and companies are rewarded for “high-trust” behavior. But stock-market returns over the past decade in “high-trust” economies do not bear that out. This leads to a highly counterintuitive, and perhaps even disturbing conclusion: Keep your money in “high-trust,” developed markets and you are heading for the poorhouse.

None of this would have struck any of my Don Corleone-like friends at the back of that Central European bar as odd. It’s just the way of the world…

It seems that in the global investment game, nice guys do finish last…





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Why John Bogle Does Not Have a Clue about Global Investing

John Bogle, the founder of the Vanguard funds and the father of index investing, is one of the best-known names in the U.S. investment world. In a recent interview, Bogle argues that foreign markets will perform about the same as the U.S. market over the next 10 years. He points out that foreign markets suffer from “unforeseen risks, currency risks, sovereign risks and more that could equalize the markets.” And while he concedes there’s a “lotta logic why global markets will grow over the next 10 years,” he does not recommend that you allocate more than 10% of your assets to developed markets and 10% to emerging markets. Overall, Bogle believes that investing your money outside the United States won’t make much of a difference to your investment returns. He contends that you might as well just play it safe and stay close to home…

I must say, this assessment left me scratching my head…

But understanding why John Bogle couldn’t be more wrong literally could add hundreds of thousands of dollars to your investment and retirement accounts over the coming decades.

John Bogle: A Pioneer on Costs and Indexing…

Bogle launched the industry’s first index fund 30 years ago and endured a lot of criticism from skeptics for doing so. But since then, dozens of academic papers have proven that Bogle was right. The only way the average investor can match the returns of the market consistently is to invest in the low-cost, no-frills offerings that he championed.

As the founder of Vanguard, Bogle’s “hammer” is a focus on index investing and minimizing costs. That’s all fine and good. In fact, one of the core investment programs that I offer to my own money management clients uses only low-cost, index exchange-traded funds (ETFs).

The beef I have is with Bogle’s asset allocation strategy. It’s here that I think he gets it completely wrong. Had you invested $100,000 in the U.S. S&P 500 on January 1, 2000, you’d be down well over 20% — even before accounting for inflation. The same $100,000 invested in fast-growing global markets – say, something similar to Vanguard’s own Emerging Markets Stock ETF (VWO) — would be worth around $290,000.

So think of $80,000 in your account versus $290,000…

That’s too big of a difference to ignore.

What John Bogle Doesn’t Get…

Bogle advises you to keep the bulk of your assets in the United States, where it’s safe from the “unforeseen risks, currency risks, sovereign risks” that characterize foreign markets. Bogle notes that even developed markets like the United Kingdom are in “poorer shape than the U.S.” In doing so, Bogle suffers from an extreme case of “home-country” bias.

Ironically, I heard the same “home-country” bias on a MoneyShow panel in London that I sat on this past Saturday. One of my British co-panelists — one of the most widely read financial columnists in the United Kingdom — advised the audience: “Don’t take the risk of investing outside the U.K. After all, 80% of the revenues of the top 100 U.K. companies come from abroad.” Meanwhile, as I sit here in Budapest, Hungary, a country famous for its financial profligacy — the local “John Bogle” is advising me to keep my money in “safe bets” like the local Hungarian national savings bank and the local national oil company. It seems that no matter where they are, investors want to put their money in companies whose names they recognize.


The Main Event: “Bogle v. Templeton”

The recently deceased John Templeton was a rare exception. By focusing on large, sweeping global investment trends — the rise of Europe after World War II and the emergence of Japan — Templeton boasted one of the longest and most successful track records on Wall Street. From its foundation in 1954, his Templeton Growth Fund grew at an astonishing rate of nearly 16% a year until Templeton’s retirement in 1992, making it the top-performing growth fund in the second half of the 20th century. A $100,000 stake invested in 1954, with distributions reinvested, would have grown to $55 million in 1999. In contrast, had you followed Bogle’s advice and invested the same $100,000 in a (then non-existent) S&P 500 Index fund in 1954, it would have grown to “only” $31.4 million.

That’s an astonishing 75% difference…

Global Markets: “You ain’t seen nothing yet!”

Global markets comfortably outperformed the S&P 500 back when the United States was by far the top dog on the global economic playground. But over the past decade alone, global markets have outperformed the U.S. market by more than 3 to 1.

This is no accident. I realized this while reading Ray Kurzweil’s remarkable book “The Singularity Is Near.” Applying Kurzweil’s insights on the pace of technological change to global investing, I suddenly realized that over the last decade, global financial markets have been expanding exponentially — the pace of change is accelerating with each passing year. But as Kurzweil points out, we humans have a really hard time getting our heads around the implications of exponential change. A picture like the one below is the best we can do.


Consider the example of China. A 10% growth rate in China 10 years ago did not have the same impact as a 10% expansion today. But thanks to compounded, exponential growth, China today plays a much bigger role in the world’s economy. In 2000, Wall Street could care less where Shanghai — the stock market of an economy barely half the size of California — closed. But last week, a sharp sell-off in Shanghai set the tone for the day’s trading on Wall Street.

Financial markets have globalized more in the past 10 years than they did over the course of John Templeton’s entire 50 year-plus investment career. It’s one thing for Bogle to warn you about the high costs of mutual funds and active investing. But to recommend investing the bulk of your assets in the S&P 500 is just plain wrong. And following that advice will cost you much more than what you’ll save by investing in any domestic Vanguard index fund.

The good news is that unlike in the days of pioneer John Templeton, there are a wide range of stocks and ETFs available to you at a click of a mouse that put this entire global investment world at your fingertips.

So whether you’re making big profits investing in the latest red-hot Chinese small cap or in a company that is making a mint betting on Asia’s Las Vegas, understand that global investing isn’t a fad…

It isn’t even the future…

It is today’s ever quickening reality.


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Making Millions in the World’s “Super-Goldilocks” Economies

Investment Ideas:

iShares MSCI Emerging Index Fund (EEM)

SPDR S&P Emerging Markets Small Cap (EWX)
ProShares Ultra MSCI Emerging Markets Index Fund (EET)

I particularly enjoy attending Russian social networking events in London, as I did last week in the bowels of one of the city’s most exclusive clubs. With a bit of luck, you’ll spot a second-tier Russian oligarch or two, clutching a copy of the latest London newspaper that his ill-gotten gains are financing. More importantly, you also invariably are greeted by a pack of smiling, 20-something Slavic beauties, who spend the evening politely stroking the egos and plying the pocketbooks of 60-something Russian “biznismen.” With the average Russian male life expectancy hovering around 63, if you’re a young Russian beauty who gets your timing right, one well-timed big trade, and you’re set for retirement before you hit 30. No more worrying about that pesky monthly IRA contribution.
As I don’t fall into either target demographic, I had a chance to chat with a young Russian Citigroup analyst, who told me that the global investment community was abuzz with talk of the latest Citibank research from his New York colleagues. Already widely cited in the media, it touted the “super-Goldilocks” investment case for emerging markets.
I perked up my ears. The young Citibank analyst’s enthusiasm reminded me of John Kenneth Gailbraith’s warning, that “the financial memory is very short.” After all, it was less than three months ago that the headlines were warning of the dreaded “Hindenburg omen,” and permabear Bob Prechter was making the rounds, predicting a collapse of the Dow to 1,000.
August 2010…

Remarkably, it only took about two months for the Hindenburg omen to be replaced by its bullish counterpart, the “Golden Cross.” I almost could hear the voice of John Kenneth Galbraith whispering to me from the grave.



…October 2010

But I also know that a good, old-fashioned emerging markets boom is one of the quickest ways to make a fortune in financial markets. You just have to make sure you have a chair when the music stops…

“Super-Goldilocks” Economies: Bulls in the China Shop — And Everywhere Else

No doubt, you are used to the relentless onslaught of bullish comments about China. But Citigroup’s report extends the bullishness to emerging markets as a whole, predicting that the MSCI Emerging Markets Index will jump 30% to an all-time high in 2011 of 1,500. That’s 12% higher than its all-time high on October 29, 2007, erasing the last vestiges of the “Great Recession.”

As Citibank put it:

“The weak, but not recessionary, macro situation in developed countries is a ‘super-Goldilocks’ environment… The underlying conditions that have driven markets higher over the past few months remain in place and are likely to do so for several more quarters.”

Citibank also noted that emerging-market stock valuations are “far from bubble territory.” That seems right. According to Bloomberg, the MSCI Emerging Markets Index is valued at 13 times analysts’ 12-month earnings estimates and 2.2 times net assets. That compares with ratios of 14.9 and 2.9, respectively, when it peaked in October 2007. Assuming emerging markets reach Citibank’s predicted level, emerging markets would hit 13 times estimated earnings and 2.8 times book value. That’s hardly an exorbitant valuation.

Importantly, Citibank is not alone in its enthusiasm for emerging markets. Long-time guru, Templeton’s Mark Mobius has said that the emerging markets rally faces no risks any time soon. Goldman Sachs’ Jim O’Neil, who I’ve spoken with about his views on China, long has said that the emerging markets party is set to go on for at least a decade. Former Morgan Stanley chief strategist Barton Biggs is even more optimistic, saying that emerging markets could double from their current levels. Given current valuations and growth prospects in emerging markets, and the prospects of markets overshooting, that forecast is not as crazy as it first may seem.

So what really has changed since the end of the summer? The answer, of course, is quantitative easing. An extra $600 billion sloshing around global financial markets has two effects. First, it devalues the dollar, sending dollar-denominated commodity prices higher. Second, with interest rates forced down, investors are sent on a desperate chase for yield, driving up the prices of all assets in emerging markets. Even permabears like Nouriel Roubini are predicting that the liquidity-driven party in global markets could go on into next year.

“Super-Goldilocks” Economies: How to Profit

With “risk back on” in global economies, the easiest way to make money is to pile into emerging markets through the iShares MSCI Emerging Markets Index (EEM). If you want an extra kick, you can invest in small caps in emerging markets through an exchange-traded fund like SPDR S&P Emerging Markets Small Cap (EWX). If you can endure even more stomach-churning volatility, you can place a double leveraged bet on the whole sector through the ProShares Ultra MSCI Emerging Markets Index Fund (EET).

One thing is for sure. If you want to tap into the boom in emerging markets, act quickly.

All financial markets have their seasons. And after a long winter, it is spring time in emerging markets…

Don’t miss out.

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“Why the West Rules for Now” — and How to Profit When It No Longer Will

Investment Ideas —


iShares MSCI Pacific ex-Japan Index Fund (EPP)
iShares S&P Global Technology (IXN)
Claymore China Technology ETF (CQQQ)
Global X China Technology ETF (CHIB)

I’ve just come back from a long weekend at my hedge fund guru friend Gunther’s mansion overlooking the Mediterranean on Spain’s Costa del Sol. From this locale, he runs one of the most successful hedge funds on the planet that you never heard of. Gunther is a smart and driven guy, and he is as obsessed with the global financial markets as he was with his earlier athletic career at Harvard. But after a weekend of endless debates on the impact of today’s U.S. elections and the Fed’s latest bout of quantitative easing on global financial markets, I was ready to transcend the day-to-day minutia of the markets for a longer perspective.

That’s exactly what I got when I came back to London, as I set off to meet with Stanford’s Ian Morris for a discussion of his new book, “Why the West Rules—For Now: The Patterns of History and What They Reveal About the Future.” Much like Yale’s Paul Kennedy did in “The Rise and Fall of the Great Powers,” published in 1987, Morris tries to make sense of our rapidly changing world by recognizing broad historical patterns that explain the rise and fall of civilizations the best. By popular — and no doubt the publisher’s demands — Morris also takes a stab at predicting the future.

Although Morris isn’t about next week’s top stock pick, his insights can provide you with a valuable perspective, taking you above the fray of the over-communicated financial media.

A Quick Overview of Past and Future

Morris traces human history from about 50,000 years ago, through the modern era’s rise of Western Europe, United States and Asia. Morris’ overarching argument is that geography — “maps not chaps” or alternatively, “latitude, not attitude” — is what matters most. One hundred years ago, it was the European Colossus that bestrode the world. For the next hundred years, it was the United States that took the mantle from Europe. But the West’s dominance of the past 200 years neither was inevitable nor is it destined to prevail forever. The world’s center of gravity is shifting eastward across the Pacific. And according to Morris’ Index of Social Development, Asia’s living standards will match those of the West by (exactly) 2103 — a precise date Morris shares with his tongue firmly in his cheek.

Morris traces human history from about 50,000 years ago, through the modern era’s rise of Western Europe, United States and Asia. Morris’ overarching argument is that geography — “maps not chaps” or alternatively, “latitude, not attitude” — is what matters most. One hundred years ago, it was the European Colossus that bestrode the world. For the next hundred years, it was the United States that took the mantle from Europe. But the West’s dominance of the past 200 years neither was inevitable nor is it destined to prevail forever. The world’s center of gravity is shifting eastward across the Pacific. And according to Morris’ Index of Social Development, Asia’s living standards will match those of the West by (exactly) 2103 — a precise date Morris shares with his tongue firmly in his cheek.

What about the future? Ensconced for the last 15 years in Silicon Valley, Morris has left behind his Stoke-on-Trent (England) based industrial roots and puts a decidedly technological spin on humanity’s future. Morris noted that the U.S. Defense Advanced Research Projects Agency (DARPA) — the folks that brought us the Internet 40 years ago — now are on the verge of putting the Internet in your head. Tiny robots injected into your blood stream can attack cancer cells. Genetic engineering will make designer babies as common as today’s test-tube counterparts. All this is a step toward the “singularity” of man and machine. The unified concerns of humanity eventually will make even the question posed as the title of the book, “Why the West Rules,” quaint and irrelevant. East and West become irrelevant concepts on our spinning blue dot.

Investments for the 21st Century?

Big-picture discussions like Morris’ would have my hedge fund manager friend Gunther impatiently muttering “Show me the money!”

Well, Morris is a serious classical scholar and historian. He is not an investment guru. But the investment advice you can cull from his insights is nonetheless important.

Between now and that fateful day in 2103 when Asia catches up with the West, invest in Asia — China, in particular — and technology.

Invest in the Future


Translating that into investment recommendations, you’d invest in the iShares MSCI Pacific ex-Japan Index Fund (EPP) and the iShares S&P Global Technology (IXN). If you want to combine both dominant themes, China AND technology, you’ve now got two (although illiquid) choices in the form of Claymore China Technology ETF (CQQQ) and Global X China Technology ETF (CHIB). And if Morris’ predictions of an integration of technology into our own life form through singularity are anywhere near on the mark, look for an Asian biotechnology exchange-traded fund to invest in during the coming years.

But it takes more than identifying big trends to make money in the markets. Even if Asia and technology are the places to be during the next two or three generations, fortunes both will be made and lost. As Morris points out, the United States went from being 50% the size of the U.K. economy in 1840 to twice its size by 1900. (Note how similar this is to current predictions about China versus the United States.) But that 60-year period also was punctuated by a nasty Civil War in the United States and more than its share of serious financial crises — including the first deep depression in the United States starting in 1873 that lasted for six long years. Only a few lucky holders of the “technology” stocks of the day — canals, railroads and steel — made any money over the period that the United States overtook the United Kingdom. Most canal and railroad stocks went the way of Internet sensation The same will happen with investors piling blindly into Chinese small caps.

Making accurate predictions about the future is harder than it looks. In my generation, college students studied Japanese and later Russian. The idea of focusing on China, whose economy was the size of Taiwan’s in 1990, wasn’t even on the radar screens of most students. And just think how different the 21st century looks from popular depictions like “The Jetsons” (1962). George Jetson may have been flying around in space — but he wasn’t texting, surfing or trading stocks on his iPhone.

Morris is gracious enough to admit that anything that smacks of prediction in his book likely will be wrong. That intellectual modesty is well-placed. After all, it wasn’t that long ago that another Stanford professor, Paul Ehrlich, warned of the mass starvation of humans in the 1970s and 1980s due to overpopulation in his 1968 mega best-seller, “The Population Bomb.”

So go ahead and invest in Asia, China and technology. It’s a sure thing until 2103 — unless it isn’t…

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