Investing in the Face of Global Instability

Pop quiz!

Sort the following quotes into whether they refer to:

a) The East-Asian financial crisis
b) The American subprime debt crisis of 2008
c) The European sovereign debt crisis
d) The Japanese lost decade

(We’ve blacked out any give-aways.)

  • ‘In response to a sluggish economy, xxxxxx tried to stimulate its economy by easing monetary policy. Credit grew quickly in the xxxxxx economy, but so too did debt. The credit expansion led to a massive rally in stock prices and real estate prices. However, the rate of debt to GDP also skyrocketed.’
  • ‘In the xxxxs, a real estate and financial bubble formed, driven by a rapid increase in lending.’
  • ‘The xxxxxx people spent more and saved less. Ultimately, the debt became too great for the xxxxxx private sector to manage.’
  • ‘…an international economic slowdown in the early xxxxs, caused the bubble to burst.’
  • ‘…unemployment skyrocketed, causing the worst economic crisis in xxxxxx since the 1930s.’
  • ‘…unsuccessful effort to defend the currency’s fixed exchange rate.’
  • ‘A real estate boom ended in a bust. The government took over nearly a quarter of banking assets at a cost of about 4% of the nation’s GDP.’
  • xxxxxx also allowed unlimited amounts of loans from the central bank to private banks because the entire banking system was guaranteed.’
  • ‘The welfare system that had been growing rapidly since the 1970s could not be sustained with a falling GDP, lower employment and larger welfare payments. In xxxx the government budget deficit exceeded 15% of GDP. The response of the government was to cut spending and institute a multitude of reforms to improve xxxxxx competitiveness.’
  • ‘…it proved that governmental spending at the levels previously experienced in xxxxxx was not long term sustainable in a global open economy.’

How did you go figuring out which comment referred to which debacle? Pretty difficult, right? We bet you didn’t get a single guess right. That’s because they all refer to Sweden’s sovereign debt crisis in the 1990s, not one of the four choices at the top.

Maybe that wasn’t fair, but our point is that each quote could be referring to at least a few of those crises. That’s because the story of each crises is so similar. And that means that we’ve seen it all before. Over and over again.

If you think that investing in times like these is difficult, you’re right. Recognising that these events happen regularly is a helpful step to sorting out your investment strategy. Do you simply wait for a lost decade to pass by before jumping into the stock market again? Is your money safe in a financial system with more than a quadrillion dollars’ worth of derivatives outstanding? Is your retirement dependent on government welfare in the midst of a sovereign debt crises?

You only have to ask yourself these kinds of questions occasionally. But when these times do come, if you have the discipline to carry out the right strategy you will be much better off.

But what sort of investment strategy do you use? What’s worked in the past?

Our regular haunt at the Markets and Money – gold – is top dog. But it’s also expensive these days. It would do well in a crisis, but it might not trend up like it has done over the last ten years. It’s still insurance against the fallibility of the political and financial system, but it doesn’t necessarily look like it has a good return baked in regardless.

So you should own some gold, but there may be better options when it comes to investing in the face of global instability.

Australian Small-Cap Investigator (ASI) Kris Sayce likes to take big punts with small stakes. He reckons that certain stocks don’t really care about what the wider market or economy is doing. At least, that’s not what matters relative to the opportunity the stocks represent. Kris uncovers stories that could provide triple digit gains. Usually they involve some sort of creative destruction – where a new idea destroys an old industry or way of doing things and replaces it with something better.

The best thing about small cap speculation, apart from the returns, is that it’s a positive and hopeful experience. You don’t spend your time worrying about what the economy or ASX200 is doing. You spend your time anticipating and hoping for a whopping gain from a great business. That makes it fun.

It’s not a small-cap investor’s job to spend time lamenting the living standards of Europe. Because it doesn’t matter what Greece is doing when there are companies out there with disruptive technologies, resource opportunities and revolutionary business models – all of which add up to stock market gains.

This might be a pretty good strategy for part of your wealth in times like these. Even if you do care and worry about the big investment trends, why not try investing in assets that don’t rely on a growing economy?

Maybe you think you’ve got the world figured out. If you know exactly how the Eurozone mess will play out, how America will overcome its debt and how China will deal with its slowdown, you might want to invest in the assets that will benefit from your predictions. This is the world of macro investing. Exchange Traded Funds (ETFs) are a great weapon of choice for the macro investor. On the ASX you can find an agriculture ETF to profit from a global food shortage, currency ETFs to profit from currency wars, government bond ETFs to profit from falling interest rates, and emerging market ETFs to profit from the few booming economies left in the world.

It’s important to know the merits of ETF investing. There’s plenty of counterparty risk investing in this way. Can you be sure of what those ETFs are really up to?

If you’re sceptical about the world of finance and like things a little more clear cut, it might be a good idea to invest in the tangible things of the world – resources. Diggers and Drillers editor Dr. Alex Cowie uncovers the ASX’s best resource stocks. And many of them are aimed directly at defending against the economic trends of today – money printing and low interest rates. Recently, one of Alex’s tips was ‘the best performing stock on the market’ for the week. If you’re interested in tangible resource investments, Diggers and Drillers may be the place to start.

Remember, most companies sell an idea. A movie, fashionable clothes or financial services to make people richer… These ideas can disappear or change very quickly, along with the business selling them. But the likes of molybdenum and beryllium are very real. Not to mention copper, iron ore and so on. Investing in something tangible means stability in the face of instability. If the price of iron ore falls, is the iron ore changing or is the value of money changing? We’re not so sure about the answer, especially when central banks are willing to print money the way they do these days. But over the long term we’ll take the iron ore over paper money.

There’s one more strategy you should know about. Income investing is our favourite way of dealing with a dodgy economic environment and the poor capital gains that go with it. In the long run, it’s by far the most reliable and profitable strategy. But it’s got some major short term drawbacks. First of all, it’s not very sexy. The payoffs take a long time to appear.

But when they do, they are very sexy. At the After America conference we gave listeners a quick example of a way to generate 4000% dividends – turning a $10,000 investment into a $400,000 annual income stream after 15 years of patience. The example was based on a real stock and its real historical performance. But slightly more realistic assumptions for the same stock’s next 15 years came out at a 100% dividend, returning $10,000 each year to the patient buyer. Imagine raking in predictable triple digit returns every year, while your friends manage it only occasionally, when they’re lucky.

But which stocks could possibly hand out that kind of performance? We’re narrowing down our shortlist. We’ll keep you posted.

Until next week,

Nickolai Hubble.
Markets and Money Weekend Edition

ALSO THIS WEEK in Markets and Money

The Skytree in Japan: A Monument to the Power of Crisis Extension
By Dan Denning

Its stock market has never recovered from its 1989 high. It has the highest government debt-to-GDP ratio of any industrial nation. And demographically speaking, it has an old population. The Skytree is a monument to the power of crisis extension. That is, with enough belief and determination, you can forestall the inevitable for quite some time. The Skytree isn’t a symbol of a rising economic power. It’s like a giant tombstone in eastern Tokyo, towering over an economy locked in financial limbo from too much debt.

The Wrecks and Smash-Ups Damaging Europe’s Economy
By Bill Bonner

Hey…this is fun! The European Roller Derby. Smash! Crash! Crunch! Whack! Fenders banged up. Radiators steaming. Tires flattened. Whee! But here’s the most exciting scene in the whole show. Greece and Germany are playing chicken! Greece presses down the accelerator and heads for Germany. “If you force us out of the euro, all of Europe will go up in flames,” say the Greeks. “Oh yeah?” say the Germans, turning on the speed in their Mercedes, “ve’ll see about that. Ve haf airbags!”

The Great Pretender – India’s Economic Past & Future: Part 3
By Satyajit Das

Petty corruption by poorly paid local officials has been common in India for decades. The real problem is a deep-seated and endemic corruption on a large scale, highlighted by scandals surrounding the issue of telecommunication licenses and sale of coal assets… Commentators now compare some Indian businessmen to 19th-century American robber-barons. Using corrupt means to access power and acquire influence over politicians, businesses have advanced their interest in several areas. They have secured rich natural resources, especially land and minerals.

Greek Game Theory: Default, Devaluation, Austerity, Deliverance?
By Nick Hubble

But there’s a problem. Nobody can agree on what a Greek default and Greek devaluation would actually mean. In game theory terms, nobody can tell you what the payoffs are. If we knew that the payoffs from defaulting but remaining in the euro were highest, then that would be the choice to make. But we don’t know the payoffs for any of the four outcomes. People can’t even agree on what each scenario would mean for Greeks, Germans, Australians or anyone else.

Nick Hubble
Nick Hubble is a feature editor of Markets and Money and editor of The Money for Life Letter. Having gained degrees in Finance, Economics and Law from the prestigious Bond University, Nick completed an internship at probably the most famous investment bank in the world, where he discovered what the financial world was really like. He then brought his youthful enthusiasm and energy to Port Phillip Publishing, where, instead of telling everyone about Markets and Money, he started writing for it. To follow Nick's financial world view more closely you can you can subscribe to Markets and Money for free here. If you’re already a Markets and Money subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Markets and Money emails.

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