Record Breaking Dow Actually Underperformed World Markets

Posted: Jan 30, 2018 11:42 AM
Record Breaking Dow Actually Underperformed World Markets

Financial news has given us breathless coverage of a Dow which breached 24k before the end of 2017, and the Dow's solid 26.7% return placed it the bottom half of easily investible nations in 2017. While US financial media tends to focus strongly on large 'celebrity' companies and indices, a wiser approach to investing is to 'see the whole board'. The wider the universe of nations and securities you consider, the more you opens up the possibility for catching the best performers. If your stock index is limited to the US then you can't possibly choose the best investments, unless they all happen to reside in one of the 40 countries with easily investible markets (which I define as countries with broad stock indices available as ETFs), which they generally do not.

The chart below tells the story:

The story of 2017 investments is not the story of a US-only bull market, but of a global bull market. Admittedly, new optimism about the shift in the US market towards more pro-business policies might well be a major factor driving global optimism, it is not the only factor, and if this is US optimism then it seems to have driven financial performance to lesser heights than it has driven emerging markets and parts of Europe.

Yes, the Dow's performance was impressive, but it lagged the global average.

Indeed, EM was the big winner in 2017. Europe was also a winner, but less so than Emerging and especially Emerging Asia. A lot of Europe's tendency to beat the US markets was due to a weakening dollar relative to the Euro which handily outpaced it.

(chart used with permission of Vident Financial)

I wrote a piece after the election of Donald Trump as President questioning the received wisdom that Trump policies, especially pro-growth policies, and also profit repatriation would cause a powerful upswing in dollar values.

I said:

"The dollar is somewhat historically overvalued

The dollar went up this much, people say: surely it’s possible that it can go up more. But this does not seem highly likely. [...] It seems that, when viewed against all currencies and against the last several years, the dollar looks like it is in bubble territory. But when viewed in longer terms, including the historic transformation in the early 1980s from a low growth, high inflation economy into a high growth, low inflation economy, the dollar looks to be at a normal to slightly high valuation. [...] I think the strongest factor to be taken into account is Mr Trump’s protectionist impulses. He doesn’t want a strong dollar. Reagan did want one. As my good friend John Tamny (Political Economy editor of and editor of Real Clear Markets) often says, 'Presidents tend to get the dollar they want.' [...] If Mr Trump gets the dollar which supports the outcome that he wants – lower trade deficits – then he’ll be getting a weaker dollar. And if he gets that weaker dollar, then, over the long run, EM countries exposed to dollar-denominated debt are likely to offer some relief against the head wind of long-term appreciation in the dollar. [...] This does not imply that it is necessary for the US to intervene in currency markets to bring the dollar down: it may just be a matter of other nations, especially China, intervening to raise their currencies against the dollar – in order to avoid trade sanctions from the US. [...] The evidence favors a strong dollar in the short run and a weaker dollar in the long run. This means that long term investors would be best served by focusing on what we know from the past in country selection: buying countries with good demographics, and manageable debt levels, which are trending towards greater economic freedom at bargain prices. Basically, for now, that means an overweight to Asia. In the initial strong dollar phase, Asia is much better positioned than Latin America in terms of dollar-denominated debt. It also benefits (less than generally perceived but still to quite a degree) from an overly strong dollar. In the long run, those parts of Asia with high levels of economic freedom have a strong growth edge."

That's pretty much what we got: A strong initial response to the Trump election in terms of dollar strength, and then for the most part a weakening dollar in 2017. Measuring it against a broad array of trading currencies, the dollar lost 9% of its value, and Emerging Asia was the star performer of the year.

Even the much-heralded dollar-strengthening effects of the foreign profits repatriation portion of tax reform have not worked as many had thought. We were skeptical of that effect as we wrote in a white paper shortly after the tax cut passed.

The bottom line is that a global investment plan does not depend on a weak US growth and investment performance story. Quite to the contrary, 'risky' assets such as Emerging Market stocks tend to do well when the US does well - often they tend to do better than the US when the US does well, because when the US is doing well, in general, anxiety levels fall and fast-growth countries' markets are allowed to rise accordingly.

To read more of Jerry's financial analysis, visit Vident Financial.