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Global Investing

The Smart Profits Report: Issue #417
Wednesday, May 2, 2007

Global Investing: Legendary Investor Predicts Triple Bubble… Here’s Four Ways To Beat It
By D. R. Barton, Jr.
Quantitative Analyst, Mt. Vernon Research

When it comes to getting information about the business world, global investing and your investments, there’s no doubt that television and the Internet are the most popular mediums. But while that’s great for news, it’s bad for insight. So much of what is spewed out is general and created for mass consumption.

It’s also why I’ve had to become much more selective in whose work I read… especially for “big names” - the nationally known folks. And when it comes to gaining truly good insight, there are just a handful of guys that provide quality analysis. Bill Gross is one. And Jeremy Grantham is another.

So why should you pay attention to these guys?

Listening To The Legends

Bill Gross, the “bond king” from Pimco is one of the most astute money managers around, running the world’s largest bond fund and fifth-largest mutual fund. He has a net worth of $1.2 billion and scoops a $40 million annual salary from Pimco.

Like Gross, Jeremy Grantham is another legendary money manager. As one of the original founders of GMO (Grantham, Mayo, Van Otterloo & Co) and current Chairman of the Board, his analysis is sound and his reasoning on timing is prudent. And today, he’s warning about a global investing bubble.

So while it’s not time to panic, it is time to plan - because the best time to prepare for a hurricane is before the wind starts blowing.

Beware The Global Investing Bubble: Why You Should Prepare Instead Of Hope

First let’s look at the two requirements for any investing bubble:

  • Excellent economic fundamentals.
  • Large amounts of liquidity leading to high levels of leverage.

Grantham makes a strong argument that both are evident in the global picture today - and actually believes that we’re currently approaching a global investing bubble in all three major asset classes - real estate, stocks and bonds.

So even if you’re a “perma-bull,” there are a few compelling reasons why you should be wary of a bubble. So let’s investigate:

  • Liquidity Is Generous And Leverage Is Cheap: You really need look no further than the sub-prime lending markets to see that cheap leverage is available across the globe. Investors have grabbed such strong returns from real estate and stocks for so long that many want to continue to take full advantage. That means looking for more ways to gain better leverage and get bigger returns per dollar invested.
  • Global Economic Fundamentals Are ALL Above Average: In Garrison Keillor’s Lake Wobegon, all the children are above average. But in global economics, all countries cannot stay “above average.” Yet that is where we find ourselves today. The Economist charted the GDP growth of 42 emerging and developed countries - and found that all were above Switzerland’s average 2.2%. Perhaps even more importantly, never before have all the emerging countries’ economies outperformed the U.S. in GDP over a 12-month period - until now.
  • The Ratio Of Returns Vs. Risk Is At All-Time Lows: Jeremy Grantham’s GMO group looks at portfolio returns in three main categories: Lower risk (heavily weighted in fixed income), moderate risk, and higher risk (more weighting in emerging markets). Their work shows that return-to-risk ratios have dropped to the lowest historical values ever. Simply put, this means that much bigger risks don’t bring extra returns. In fact, they’re giving smaller adjusted returns.

When Leverage And Liquidity Are Ignited

In recent history, the stock market has provided two prime examples of what happens when leverage and liquidity are high and a trigger happens in overstretched markets.

  • May 2006: In just a three-week period, we saw emerging markets slump a whopping 25% amid signs that the carry trade in the Japanese Yen might be winding down.
  • February 2007: Cracks in the sub-prime market and a largely unrelated 9% single-day drop for the Chinese market showed that although the markets have climbed the cliff impressively, there is certainly loose footing at the edge.

But now is not the time to panic. Instead, you need to do some smart planning…

Four Ways To Avoid Getting Busted By The Global Investing Bubble

Here are four steps you can take today to avoid getting caught up in any global investing bubble fallout:

  • Beware The Bias: The best thing you can do is make sure the filters you use to view the markets aren’t too rose-colored - i.e. biased to the upside. Stock prices and real estate prices don’t just move up. However, sitting on the sidelines long-term is an unacceptable alternative, because large returns are still possible. Remember that if this is a global investing bubble, almost all bubbles end with explosive moves to the upside.
  • Balance Your Portfoli Take a look at your portfolio and make sure it’s not too heavily weighted towards emerging markets or regions more susceptible to high volatility.
  • Forget Timing: Don’t try to time the market top or global investing bubble. It’s a difficult business at best - and one that nobody gets right on a consistent basis.
  • Stop Loss! Any prudent investor always makes sure he has stop-losses in place - and sticks to them.

Great trading,

D. R. Barton, Jr.

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Today’s Smart Profits Cribsheet

  • With a mass of conflicting market data swarming the market, investors often face a difficult task separating fact from fantasy. While the explosion of the financial media has certainly given investors more access to information than ever before, it’s also triggered “one-size-fits-all” commentary. But a great way to cut through the fluff and gauge the mood of the market is to analyze the CBOE Volatility Index (VIX). Many successful traders use this proven tool to evaluate whether investors are overly complacent (not concerned about a market correction) or fearful (worried about an imminent selloff), so they know the best time to buy and sell. For more on the VIX, check out Smart Profits #381, The Market Volatility Index: Using The VIX To Straddle And Strangle Stock Options.
  • Even better… you should listen to the pros. Today’s message mentioned two of the best money managers in the business - Bill Gross and Jeremy Grantham. The proven expertise of guys like this is invaluable - and both Gross and Grantham are featured in a new report that reveals 31 proven “secrets of the masters.” The successful wealth-building strategies they reveal will show you how to consistently dodge the stock market’s bullets and turn every $10,000 into $56,300. For more information, click on this link.

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The Chart Of The Week

Americans' dwindling savings rate

March 2007 marked the 24th straight month that Americans had a “negative savings rate.” Because this trend has continued for so long, it’s caused many to sweep it under the rug. Many explain it away because of “wealth” reasons: With more equity tied up in their homes, Americans don’t see the need to save. In next week’s article we’ll look at why this is a lame argument on several fronts. But for now, take a look at the chart, showing Americans’ dwindling savings rate.

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