Part of the difficulty with analyzing equities is assessing the international strength of the economy. A strengthening dollar and falling emerging market GDP growth will have a negative impact on multinational companies.
Global economic backdrop
Source: Ycharts
The iShares FTSE China ETF declined 22.61% year-to-date, iShares MSCI Brazil Capped ETF fell by 14.04% year-to-date, and the iShares MSCI Spain Capped Index Fund depreciated by 5.78% year-to-date.
Brazil is being hit by high rates of inflation with low rates of economic growth. Typical monetary easing tools cannot be used in Brazil; monetary easing would only increase the rate of inflation. This is why Brazilian stock values are falling, and the Brazilian central bank isn’t out purchasing assets due to inflationary risk.
China is facing its own sets of issues. The economy is transitioning into a service based economy. As a result, China is focusing less of its attention on exports. Processing trade inflates the total economic output without having any real impact on the economy. Reducing exports and focusing on consumption will cause falling rates of GDP. The Chinese economy may get a boost if the People’s Bank of China were to initiate accommodative monetary policy. Many outward looking forecasts assume a drop in GDP in 2013, with a recovery in 2014. Hopefully the Chinese government initiates monetary easing and offsets the decline in GDP.
Spain is in the middle of the pack. Austerity measures have pushed Europe into a double dip recession. It’s very likely that accommodative monetary policy (asset purchases and low interest rates) will persist for the rest of the decade. Fiscal stimulus is almost a no-brainer at this point, but Germany’s fear of hyper-inflation has made it difficult for the European economic block to initiate fiscal stimulus policies.
Buy U.S. equities
In the face of global uncertainty investors have invested heavily into U.S. equities. The greatest advantage of owning U.S. equities is the international exposure multinational companies have. It’s an indirect play on the global economy, and the stable growth in the United States GDP helps to keep a floor underneath U.S. equities.
Based on the economic challenges that Europe, China, and Brazil are currently facing, it can be assumed that a diversified play like owning the SPDR S&P 500 (NYSEMKT: SPY) could be the most lucrative choice for investors who want a reasonable mix of return and risk. The SPDR S&P 500 has a distribution yield of 2.08% and has a market capitalization of 149.3 billion. An overwhelming number of investors have opted to own U.S. equity index funds as a practical hedge against global economic uncertainty.
The currency backdrop
The recent bond market sell-off triggered a rally in the value of the dollar. The dollar for a moment at least, was considered the hedge against both bond and stock market volatility. However, the bond market has not been able to recoup all of its losses while the major stock indices like the Dow Jones Industrial Average and Standard & Poor 500 have been able to recoup losses. The trend clearly indicates that stocks are the way to go.
Source: YchartsThe dollar index has appreciated by 3.35% year-to-date. The eventual tapering of quantitative easing will cause the dollar to appreciate. The assumption is that because other currencies will be undergoing accommodative policies (Europe and China) the value of the dollar should be able to appreciate against a basket of currencies. Because of this I believe that currency related losses will persist for both The Coca-Cola Company (NYSE:KO) and Johnson & Johnson (NYSE:JNJ).
