Decoupling Is Still Dead And Here's The Proof

by Louis Basenese

Decoupling Is Still Dead And Here's The Proof

by Louis Basenese, Senior Analyst

Wednesday, June 10, 2009: Issue #1015

Last August, in an exclusive article, I badmouthed decoupling - the theory that the rest of the world (particularly emerging economies) could somehow party on while the U.S economy endured a recession.

A quick glance at the scoreboard proves my criticism was spot-on...

While the S&P 500 Index slumped 38.5% in 2008, 30 countries witnessed drops of 50% or more. Even more telling, the poster children for the decoupling trade: Brazil (-41.2%), Russia (-72.4%), India (-52.45%) and China (-65.39%) didn't escape punishment either, despite wild predictions they would...

Clearly, the old adage still applies, "When the United States sneezes, the rest of the world catches a cold." (Or in some cases, like Russia, they get pneumonia.)

So why resurrect the past? Because decoupling diehards won't let this junk science die. And sadly, another warning is in order...

Decoupling 2.0 - Redefining The Theory

On the back of an impressive rebound in emerging markets this year, the decoupling chatter is back. Only this time, followers are calling it "Decoupling 2.0." And they've redefined their theory...

As The Economist reveals, "Decoupling 2.0 is a narrower phenomenon, confined to a few of the biggest, and least indebted, emerging economies." Ones with "strong domestic markets and prudent macroeconomic policies."

Funny. I read that "redefinition" and think how badly some pundits want decoupling to work out.

It's still the same farce, however.

  • You see, globalization - an undeniable, decades-old, economic force - created one quantum entanglement.

  • World markets are inextricably tied together in knots, whether we want them to be or not.

  • And if they can ever be untangled, it will take years (likely decades), not a few quarters.

So, as the Decoupling 2.0 banter picks up, let me offer up a dissenting voice - and warn you.

First, don't be mislead by the headlines...

  • Yes, Chinese stocks are up 44.6% in 2009.

  • Yes, Brazil rebounded 39.7%.

  • Yes, India staged a 51.6% comeback.

  • Yes, Russia came roaring back 72.1%.

  • And yes, the United States only mustered a pathetic 0.22% gain.

  • But nothing's really changed.

The United States remains the engine of economic growth. How else do you explain the fact that the equity markets continue to move in lockstep?

As you can see in the chart below, some of the BRIC nations started to rebound sooner, but they sold off in February, just like the United States. And they didn't really gain momentum until after signs that the U.S. economy would fight another day materialized.

Decoupling is Dead - BRIC Nations Rebound

Chart Source: Bespoke Investment Group

Decoupling Advocates: Countering The Obvious With Nonsense...

Decoupling adherents will counter this evidence, saying the equity markets might still be coupled, but the underlying economies most certainly are not. Nonsense.

If an economy is doing well that means businesses are doing well. And if businesses are doing well - and most are publicly traded - stock markets will be doing well. You can't separate the two.

That leads me to the second part of my warning. Whatever you do, don't abandon your U.S. investments or significantly overweight your portfolios to these "decoupled" international markets.

If you did so the last time, your portfolio got hammered. In fact, if you moved all your investments into China or Russia at the start of 2008, like some investors I know, you're still worse off than the patriotic fellow that invested in nothing but U.S. stocks.

A hypothetical $100,000 portfolio of U.S. stocks is now worth $61,655, compared to $50,046 had you held all China stocks, and $47,500 had you had nothing but exposure to Russian stocks.

While Decoupling May Be A Farce - Don't Ignore Emerging Markets

Let me be clear, although decoupling is a farce, that doesn't mean we should ignore international and emerging markets altogether. That would be foolish. These markets lay claim to stronger domestic growth and more options (higher interest rates and billions in foreign reserves) to stimulate further growth.

What I am recommending, instead, is that you capitalize on these strengths in a more intelligent manner. Instead of going "all-in" so to speak, place a more reasonable wager. Specifically, stick to the tried principles of asset allocation. After all, the theory behind it won a Nobel Prize. Meanwhile, Decoupling 2.0 isn't even legitimate enough to garner a nomination.

So instead of plowing all your money into international stocks, only allocate a portion. At IU we recommend a 30% allocation to international stocks. That's just the right amount of exposure to profit, without taking unnecessary risk.

In terms of specific investments, I recommend the low-cost, no-hassle, diversified, indexing approach.

  • Either the iShares MSCI EAFE Index (AMEX: EFA), which holds positions in 838 companies.

  • Or the iShares MSCI Emerging Markets ETF (AMEX: EEM), which holds positions in 340 companies.

  • If you want a more concentrated, high profit potential pick, hire a professional. Specifically Mark Mobius and the Templeton Emerging Markets Fund (NYSE: EMF). No one can touch his 40-year track record in emerging markets, even recently. Since the March 9 bottom, his closed-end fund is up 65%.

Good investing,

Louis Basenese

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