THERE has been no dearth of sensational headlines relating to the financial world in the media over the past few weeks. Oil prices are fast approaching US$100 per barrel. Financial institutions are taking accounting charges for sub-prime write-downs. CEOs have stepped down. The US Federal Reserve has lowered interest rates to ease credit in a slowing economy. Unemployment rates are down and inflation is an on-going worry. Minerals and metals, especially gold, are trading at new highs. The US dollar is sliding fast. Global stock markets have been very volatile.
How should a Singapore investor respond to all of these issues? Let's examine the fundamentals of the US economy, and the US stock market and assess how macro economics affect the value of the US dollar and investor behaviour.
The US economy
Our prime minister was recently asked about the possibility of a recession in the US. He said 'perhaps'. But will a recession in the US affect Singapore? He replied 'most definitely'.
The total decoupling of the US economy from the rest of the world has not materialised and global economies are intertwined in terms of economic cycles (see Chart A).
The arguments for the outlook of the US economy go something like this. The probability of a full-blown recession is less than 50 per cent, based on broad consensus. US home prices will probably decline further and we have not seen the end of the sub-prime mortgage mess.
Containing inflationary pressures in the US will be a continuing challenge for the Fed as it lowers interest rates to avoid a hard landing. Lower interest rates translate into lower exchange rates for the US dollar. This anticipated decline in the US dollar will make American exports more competitive and improve the earnings of some US companies.
The US trade deficit will improve in the near term and may check the fall of the dollar.
If the US real economy maintains such a course, the Asian story will go on. This means that Singapore investors should strike a balance by staying invested in global securities for diversification and risk management of their investment portfolios.
There is no reason to dump US securities within a diversified portfolio based on concerns about the possible slow growth of the US economy in the near term.
The US stock market
The valuation of US shares will be of interest to investors. The forward price earnings (PE) ratio of the S&P 500 is now at 15.7 times compared to the pre-bubble 60 times in 2000. In fact, we should turn our attention to exposure in emerging market equities.
Equities in China, India and other emerging markets have appreciated at a much faster clip than those of the developed markets in the last two years due to strong GDP growth. The sensible course of action for an investor is to rebalance a portfolio that has a heavy allocation in emerging markets to a more broadly diversified one because the likelihood of repeat performances in the near term is hard to predict.
Human behaviour is such that not only is the exposure to emerging markets, including Asian stocks, preserved but there may be a tendency to chase performance with fresh capital infusion into Singapore and Asian shares just because there is negative news from some American companies.
Going back to US shares, on average, 25-50 per cent of sales and earnings of US-listed companies come from abroad. This is good news for the global investor.
One can argue that the weak US dollar will contribute to higher earnings for American companies with positive impact from foreign currency translation in the financials. So whether the US economy goes into a recession or not in the near term, some large-cap US equities will continue to deliver growth from sales to the rest of the world in the long term.
Nestle is an example of a global player whose country of listing is not relevant when compared to the company's sources of revenues (see Chart B).
Even if the US stock market experiences volatility in the near term, there is no case to avoid quality shares listed in the American stock exchanges for a long-term investor.
The US dollar
The Monetary Authority of Singapore has decided to accelerate the appreciation of the Sing dollar versus a managed basket of currencies. This policy is aimed at tackling inflation in our domestic economy. The outcome is a manifestation of the weakening US dollar.
The point is, the Sing dollar is not the only currency that is strengthening. Our currency is moving in tandem with the euro, yen and other regional currencies (see Chart C). But there is no escaping the US dollar for a global investor. How else can you buy into Berkshire Hathaway and Microsoft or Coke and Pepsi?
Procter & Gamble (P&G) owns Pringles, Braun, Gillette, Tampax, Max Factor and Duracell. The only way you can be a shareholder of the company that owns these global brands is to buy P&G shares denominated in US dollars. A global equity portfolio will include companies like P&G.
Whether the direct shares, private equity or unit trusts are denominated in the US dollar, Sing dollar or Australian dollar, it makes little difference in the long term as long as the underlying securities represent profitable companies around the world. It does not make sense to own only shares in companies with strong currencies compared to the US dollar.
Timing the market is next to impossible. Adopting the correct time horizon for specific investment objectives is, however, essential.
Staying invested in the market for the long term is the only way to achieve long-term goals such as retirement funding. The more frequently investors evaluate their returns, the more likely they are to make inappropriate short-term decisions because myopic loss-aversion causes such investors to treat the long-term as a series of short-terms. Leading behavioural finance researcher Hersch Shefrin explains this framing concept in his book Beyond Greed and Fear.
So should we be concerned about the US dollar or something far more important?
Going back to basics: review your goals, decide how much is enough in S$ medium- to long-term returns, get the asset allocation right, insist on quality underlying securities without undue concern about the currency of denomination and assess if overall risks for total investment assets are appropriate to your investment time horizon.
Old-fashioned dollar cost averaging will cover market and currency fluctuations in the medium and long term. Never react to market chatter. Stay invested. Once the framework is in place, allow the strategy a chance to work.
Roy A Varghese is Director, Financial Planning Practice, at ipac Singapore. The views expressed are his own. He can be reached at firstname.lastname@example.org