The World at a Glance

Tuesday, June 08, 2010

Global correlation is the name of the game right now. Besides gold, investors have not been able to find much safety across the world since the beginning of 2010. With cash offering a paltry return, the search for yield is hot yet there is not much to be found so far this year. While portfolio diversification of at least 20 securities is now seen as the basic standard all investors should follow, I am awaiting more academic research into the shift in systemic risk (market-wide risk) versus idiosyncratic risk (risk associated with a particular security) as selling pressure rises in markets. In rising markets, the greatest risk is idiosyncratic in that an investor will carry too much exposure to an individual issue and could suffer should that stock see a black swan event. Yet, in falling markets, the risk seems to shift and systemic risk rises greatly relative to security-specific risks. The benefits of diversification are lost because correlation between stocks, markets and asset classes jumps. Hence, diversification is beneficial as markets rise yet useless when they fall (the time in which you need those benefits most). I have no concrete study to reference on this but would I love to see a finance professor somewhere prove or disprove these observations.

The American equity market is now 13.7% off the April 2010 high dropping as fears of contagion from Europe's debt woes rippled over. This correction should be kept in the context of the overall move though, a relatively minor pull-in considering the non-stop 70% rally off the March 2009 bear market lows. Plenty had been expecting the correction for months yet it is always amazing how quickly stocks fall, they go up on an escalator and down on an elevator.

Greece has fully collapsed along with the euro. I have had some ask me whether I think the crisis in Europe could become really bad. Well, for Greece, with its equity market down nearly 50% (remember our maximum intraday decline from high to low was 57.7%) it is really bad. The other PIGS are solidly in bear markets down over 20% as the European Union attempts to calm markets with its debt aid package planning. While I think the EU plan is a good one, I see no quick resolution to Europe's problems as the continent suffers from a debt overload and seriously lacks the prospect of new growth opportunities to turn the economy around.

China is also over 20% off its highs and has now based for months after making its recent highs in November 2009. The Chinese government has been consistently tightening monetary and fiscal policy in an attempt to cool an overheating real estate market. Some worry that the Chinese government may go too far and induce a recession as unchecked contractionary policy often can. Yet, with foreign exchange reserves valued at $2.4 trillion and annual GDP of $4.3 trillion, any marked slowdown could easily be countered by government spending and it seems to me this recent consolidation action in Chinese equity markets may be a great time to become an investor.

YTD Return
% Off Most
Recent Highs*
United StatesS&P 500
United KingdomFTSE 100
GermanyDAX 30
FranceCAC 40
Hong KongHang Seng
ChinaShanghai SE
PortugalPSI 20
ItalyMIB 40
SpainIBEX 35
Euro CurrencyEUR/USD
*Most recent highs within that last year.

Disclosure: Long GLD, FXI.
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