Friday, August 15, 2008

The Worst Except For Everywhere Else

Winston Churchill once opined that "democracy is the worst form of government except for all the others that have been tried." That was a man who knew many truths are relative. Likewise investment markets and economies are about options, their relative benefits and performance.

For all the wailing on Wall Street, the U.S. market has held up relatively well. Having said that, we can't eat relatives and absolute returns are what we are looking for ultimately. Drowning by inches is no better than drowning by feet. This is the time for capital preservation and opportunistic buying AND selling.

In the relative performance chart above there are clues to be found about the global economic currents and investment strategies. What do we see that creates the backdrop for our decisions? There is somewhat of a parallel to the US boom real estate markets in many of the performances. The trading cliche', "when in doubt zoom out," is a good one. Step back when strategizing.

In the government statistics for housing through the first quarter of this year, we see tremendous declines in average house prices in various markets. Naples, Florida decreased 18.67% over twelve months. Conversely in our corner of the world, Pittsburgh, PA, average prices were actually up 3.61%. Cause for celebration? It depends. Over the past five years, Naples housing prices are still up 60.55% while Pittsburgh has advanced 22.83%. Now that the euphoric bubble has burst painfully can we learn anything to apply in other areas?

Does the prospect of buying in Saginaw, Michigan,which fell only 3.38% in the past year look more attractive than the Florida Gulf Coast over the longer term? The catalysts that are moving populations southward and westward in the United States seem unlikely to reverse and drive migration to Saginaw.

Similarly, the emerging markets are among the markets that have fallen hard this year. But does the global shift in wealth toward these markets, the high population growth and youthful demographics seem at risk. Will China and India slow? Probably. Will the inexorable power of the underlying thesis of globalization reverse? Unlikely.

We have stepped back from the emerging markets somewhat, believing that there exist some persistent valuation issues as a result of a "crowded trade" not unlike the home prices in Florida and Las Vegas. But stepping back is not stepping away.

For the coming year, I expect the difficult conditions felt in the U.S. economy will move more steadily overseas. The US still represents a safer haven in times of turmoil and the capital inflows indicate a reversal back toward the US. Does that mean US market prices will climb steadily, not necessarily, but for now, it looks like the US is the worst except for everywhere else.

John Barnyak
Stonehouse Asset Management