False diversification and the U.S. world position

[Wayfare]

While all reasonable investors are diversified somewhat in the stocks / industries they have positions in, almost all of these stocks are usually (in my experience) in U.S. markets. Why are we all so confident that the United States will continue its run of stability and sustained growth? If there is a catastrophic change in the U.S. economy, our "diversification" would be completely hollow. Some points that cause concern.

Biggest ever trade deficit / budget deficit

Foreign direct investment "Bubble"

Long-term fiscal insolvency issues

Continuing target in escalating battle with terrorism

Political leaders with questional ability to handle situation acceptably

The doomsday scenerio is that some event (financial report, scandal, terrorist attack) causes panic in the United States and leads to foreign capital flight. This would lead to dollar depreciation and a loss of purchasing power and ability to pay back our foreign debt.

WSJ wednesday says that while other countries have been devestated by financial conditions similar to that of the United States (in terms of deby and current account deficit) but that the United States is "special" due to its high FDI and position in the world. Today WSJ skeptically asks whether America will be able to sustain its FDI growth indefinately, which has risen from $175B to $700B+ in the last ten years.

Anyone else worried enough to start heavily diversifying internationally? I am.

[parttimepro]

Agreed. It's pretty clear that the dollar has not fallen further mainly due to intervention by foreign central banks (Japan and China). This may continue for some time, but it's hard to conceive of a situation where the trade deficit will fix itself without a weaker dollar.

This does not mean that the dollar will proceed on an orderly path to an equilibrium valuation. Because of the possibility of intervention (either foreign banks buying treasury notes, or the fed raising interest rates), we may see dramatic short-term spikes upward in the value of the dollar.

The easy money from betting against the dollar has already been made. By the time macro-economic trends pop up in popular literature (e.g. Time magazine), it's too late to make great profits. Barring a sudden outburst of fiscal responsibility across America, in 5 years, the dollar will be lower, but it's not possible to make accurate short-term predictions.

As you said, it's a matter of diversification. We don't know what will happen to the US economy, but we shouldn't put all our eggs in one basket. However, simply buying foreign index funds does not distribute the risk as much as you might expect. Most foreign economies are dependent on exports to the US, so a major dollar devaluation may cause a worldwide recession. I think foreign utilities will outperform in this situation, as demand for their products will not be affected much by economic conditions.

[laserboy]

I like the way both of you think! [img]/images/graemlins/smile.gif[/img]

Any good investing ideas? Any particular foreign utilities you like? I have been looking at SKM. South Korea is dirt cheap right now and I anticipate their currency will continue to appreciate like a mofo. SKM has great numbers and the Koreans are real power users when it comes to cell phones. They have awesome technology and are making inroads to China, so there is a growth story there as well. It gives a nice dividend too. Of course, their economy is screwed once we have maxed out our credit cards and can't afford any more of their electronic toys, but I have not yet decided how that will affect their cell phone usage.

I am mostly in cash and commodities right now, but I think the time is ripe to go short. A lot of my "hysteria indicators" are dropping like flies (TASR, EBAY, SIRI, TZOO, etc.). I will definitely start opening some short positions if we have another mini-rally. I really want to short the hell out of WPTE.

[parttimepro]

I own KEP right now, Korean Electric Power. Good free cash flow, with potential to grow into the China market. I like it because it can grow with good economic times and be fairly resilient with bad. Looks like the main risk factors are the exchange rate and a big spike in energy costs (which can be partially passed on to consumers).

Haven't looked into SKM. I'm somewhat leery of telecoms, just because they are generally more volatile and more connected to economic cycles. SKM may be different, I don't know. I think South Korea long term has great potential, with North Korea being the big question mark. From a business perspective, the status quo is probably most profitable. War would obviously be terrible, and even a peaceful reunification would likely slow growth significantly in the intermediate term, as it has in Germany. Doesn't look like either is going to happen soon, though.

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I really want to short the hell out of WPTE.

[/ QUOTE ]

Yeah, if nothing else as a hedge against the declining popularity of poker. If the fish tank dries up, I won't be able to make nearly as much at the tables. It's hard to tell how much longer the poker boom will continue. Personally I think the show Tilt is a sign it's jumped the shark. We'll know it's happened when registrations for the WSOP stop going up.

I had read somewhere on these boards speculation that Party was offering these bigger reload bonuses in order to show monstrous growth in preparation for an IPO. If that's true, it's definitely a short/put candidate.

[laserboy]

KEP looks interesting as well. Their free cash flow is not quite as impressive as SKM relative to enterprise value(their capital expenditures and debt are massive), but they are certainly dirt cheap. .46 Price/Book and 4.67 Price/Earnings for a company with more than $1Bil/year in free cash flow... WOW.

The thing I like about SKM is the business model. Their covered geography and population is small and compact with extremely high cell phone penetration rates, so their capital expenditures are small compared to (for example) US telecom companies (the same could be said for Korean electric companies). Their infrastructure is already built out at this point, so in an economic downturn they would be pretty much free to sit back and collect the monthly bills (kind of like AT&T in the old days, when their biggest capital expense was printing and mailing out the monthly bill). This is evident in their high free cash flow and profit margins. Also the Koreans are notoriously early adopters when it comes to technology, so as the leading telecom company, they stand to benefit immensely from emerging value added services like streaming video, gaming, and internet access.

From what I have read, North Korea is in pretty bad shape and the possibility of war is somewhat overblown. I tend to consider "scares" like this as buying opportunities. Of course, I am just a poker player not a foreign relations expert, so don't take anything I say seriously. [img]/images/graemlins/smile.gif[/img]

In fairness to Party Poker, they are actually a great business. WPTE is just an absolutely scam designed to cash in on the poker boom at the expense of idiot investors. They are priced like a growth stock that is going to change the world, yet all of their growth is behind them. They produce a mildly successful TV show and that is it. I am convinced that the PPT and WSOP Circuit will actually dilute the popularity of their product at a significant expense rather than add to their earnings. I think its hilarious that they talk about stuff like "WPT branded merchandise" as a growth driver as if their "I have bigger nuts than you" T-Shirts are going to change the world. LOL!

[lehighguy]

Without getting into details you right about the precarious posistion of the US right now. Hell, the whole world is in a precarious posistion. I would split my money even between all the major currencies and some emerging markets. Good ideas on some of those stocks too.

[laserboy]

I definitely agree with you that it's a tough investing environment to be in right now. Warren Buffett has flat out stated that there is nothing out there worth buying. But it's a big world and there are a lot different investment opportunities. It's not all doom and gloom

FWIW, I am bullish on commodities long term and I think we will get to witness the re-emergence of the Chinese empire within our lifetimes.

[adios]

Simple question, how do you know when your portfolio is diversified correctly?

[Dan Mezick]

This link may help answer your question. Short answer: 20 "negatively correlated" holdings are all you need.

Diversification Explained Simply

[adios]

[ QUOTE ]
Short answer: 20 "negatively correlated" holdings are all you need.


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That's not what the article states at all. It basically states that you can eliminate individual company risk by owning 20 stocks. Anyway if your statement is correct then it doesn't matter if I own foreign stocks or not.