Another Lost Decade for Investors?

11/24/2009 10:27 am EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

Since 1999, the S&P 500 has been a real loser. With three simple truths and a gaze toward foreign shores, you can position yourself favorably for the next ten years.

The past ten years have been a lost decade for many investors.

If you had invested $10,000 in the Standard & Poor's 500 Index in October 1999, a decade later you would be looking at a loss of more than $900. Lock your money up in stocks for ten years and lose 1% a year? It's not supposed to work that way.

So what about the next ten years? It might be just as grim for many investors, who are still sitting on portfolios that are likely to make the next decade as unrewarding as the last.

But it doesn't have to be that way.

Let's rewind to 1999 and imagine that instead of putting all your money into an S&P 500 fund, you had invested in China—say, by buying into Matthews China (MCHFX). Instead of a 1% annual loss, you would have seen an average annual compounded return of 18.17% for each of the next ten years.

Of course, few people recognized way back then that China would be the investment story of the decade. Let's say that instead, you had simply bought into a mutual fund that invested broadly in emerging markets, such as the T. Rowe Price Emerging Markets Stock Fund. Your average annual compounded return for the ten-year period would have been 12.06%.

Ready to have a good cry?

  • If you had invested $10,000 in the S&P 500, as many people did, you would have been left with just $9,090.52 after ten years.

  • A $10,000 investment in T. Rowe Price Emerging Markets would have grown to $31,225.27.

  • And a $10,000 investment in Matthews China would have grown to $53,097.29.

And you know what's even worse? Ten years ago, the conventional wisdom preached diversifying a stock portfolio by putting a hunk of money into overseas markets and a piece of that into emerging markets.

Simply following the prevailing common wisdom ten years ago and putting 10% of your money into emerging stock markets would have turned your 1% annual loss on a 100% S&P 500 portfolio into a small gain, leaving you with $10,357.53. That's a not-so-hot 0.35% average annual compounded return.

But a gain is always better than a loss, and getting a $1,267 swing to the good on a $10,000 investment just from making one easy-as-falling-off-a-log asset allocation decision is a pretty decent return.

Anybody who doesn't think $1,267 isn't real money is welcome to send it to me.

A Question of Balance

You can't go back in time and redo your underexposure to overseas stocks, in general, and emerging market stocks, in particular, but you can try not to make the same mistake in the next ten years.

All the evidence, though, is that US investors are about to do it to themselves again.

The US share of the global stock market is falling as other countries build larger economies and deeper capital markets. In 2004, US capital markets accounted for 53% of the value of all shares in the world that were free to trade, according to Standard & Poor's. (Many shares in markets such as China and India are locked up under government control and aren't free to trade.) By 2007, that percentage was down to 44%, and by 2008 it had fallen to 41%.

Asset allocation by US investors hasn't kept pace with that change. Depending on what group of investors you measure, US investors have somewhere between 2% and 20% of their equity portfolios in overseas stocks. Among 401(k) investors, about 12% of their stock portfolios are in overseas stocks.

If you simply look at the makeup of the world's equity markets, US investors are heavily overweighted in US stocks and seriously underweighted in foreign stocks.

The Rise of Developing Nations

That might not be so devastating to the portfolios of US investors if the US economy were projected to outperform the economies of the rest of the world. But it's not. The Organization for Economic Cooperation and Development, or OECD, projects that the US economy will grow 2.5% in 2010 and 2.8% in 2011. China, in comparison, is projected to grow 10.2% in 2010 and 9.3% in 2011. For India, forecasts read 7.3% growth in 2010 and 7.6% growth in 2011. For Brazil, 4.8% growth in 2010 and 4.5% growth in 2011.

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But not all the world is projected to grow faster than the United States. Japan and Europe will lag the US economy, according to the OECD. The euro zone economies are expected to grow just 0.9% in 2010 and 1.7% in 2011. In Japan, 1.8% in 2010 and 2% in 2011.

The outperformance in China, Brazil, India, and the rest of the developing world isn't projected as a one- or two-year thing either. It should last a decade or more, powered by younger populations, faster-growing productivity and lower post-financial-crisis debt burdens in comparison with their developed-market counterparts.

A No-Brainer Solution?

What you should do to avoid a repeat of the past lost decade is obvious, although it undoubtedly feels extremely daunting.

You should gradually work to increase your allocation toward overseas stocks, with an emphasis on the equities of the world's fastest-growing economies, toward something like the actual weighting of global capital markets.

There are lots of reasons that feels hard. I've been working for the past five years or so in my own portfolio to achieve an allocation like that, and I'm not there yet. Let me tell you from experience why it feels so hard, and I'll tell you about the strategies I'm using to get past those difficulties.

Obstacle No. 1: It feels like I've missed the boat. The iShares FTSE/Xinhua China 25 (FXI) exchange traded fund is up 55% this year (as of November 18) and 103% in the past year. The iShares MSCI Brazil Index ETF (EWZ) is up 120% in 2009 (as of November 18) and 97% in the past year.

Solution No. 1: Remind yourself that it's early in the ballgame. Deciding not to invest in China or Brazil now is like a 19th century investor saying he doesn't want to buy into the future of the United States in 1875 because he missed the post-Civil War boom. Wait for corrections and busts. The iShares Brazil ETF was down 54% in 2008, let's not forget. And realize that a long enough holding period and a strong enough performance will wipe out a lot of timing mistakes.

Obstacle No. 2: Who knows anything about Chinese solar companies or Indonesian cell phone operators or Indian banks? McDonald's and General Electric and Apple are names I know. I can go out and visit a store. I buy their products. And when I need information, I can get it from Standard & Poor's or my online broker or on the Internet. But just try to find decent information on Telkom Indonesia.

Solution No. 2: Take it slow. You don't have to become an expert on any of these companies to invest in them, thanks to the growth of actively managed mutual funds and ETFs that follow single-country indexes. Buying iShares MSCI Brazil is a great way to add Brazil to your portfolio. Owning it will—if you poke around in the lists of the fund's holdings you can find online—give you an entry point into learning more about individual companies.

In some cases—and Brazil is one—you've even got a choice of ETFs that will give you an exposure to different pieces of an emerging market. For example, in my Jubak's Picks portfolio, I own the Market Vectors Brazil Small Cap ETF (BRF) to get exposure to more of the domestic consumer economy. (For more on that buy, see my original recommendation from September. About 30% of my Jubak's Picks portfolio is now in true overseas stocks, and I plan to increase that percentage over time.)

Obstacle No. 3: I feel like everybody is chasing the same handful of stocks and the same two or three markets. I'm worried that I'm buying just in time to be the fool of last resort so that the early, smart money can sell.

Solution No. 3: Recognize that emerging markets are a constantly changing, new-world pecking order. If China is the next United States and India is the next China and Brazil is the next India (whew!), then who's the next Brazil? At the moment, I'd say Indonesia. The country shows signs of moving down the same path that Brazil started down 15 years ago. There is already an ETF, Market Vectors Indonesia (IDX), but it's less than a year old. Another emerging economy to watch is Turkey's. The iShares MSCI Turkey ETF (TUR) goes all the way back to 2008. In the case of both Indonesia and Turkey, you can also buy an older closed-end mutual fund, such as Turkish Investment or Indonesia Fund.

And finally, in many newly emerging markets, the dominant telecom company often makes up a huge share of the market's capitalization and gives you a good single-stock way to buy into the market. In the case of Indonesia, the company is Telkom Indonesia (NYSE: TLK), and in Turkey, it's Turkcell Iletisim (NYSE TKC).

I'm looking to buy one or both of these for Jubak's Picks in 2010.

Slow and steady works best when you're expanding an asset allocation. After all, the decade will be new for a few years yet.

At the time of publication, Jim Jubak owned shares of the following funds and companies mentioned in this column: iShares MSCI Brazil, Market Vectors Brazil Small Cap, Matthews China, Telkom Indonesia and Turkcel Iletisim.

Jim Jubak has been writing "Jubak's Journal" and tracking the performance of his market-beating Jubak's Picks portfolio since 1997 on MSN Money. He is the author of a new book, The Jubak Picks, and he writes the Jubak Picks blog. He is also the senior markets editor at MoneyShow.com.

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