Some may remember the Broadway musical, “Stop the World, I Want to Get Off.” The title’s message, also found in the Bible, is that the world is too much for us. Today almost every activity we do is the result of product, services, influences or fears of the same from beyond our borders. The very act of watching the Super Bowl is being done on television sets that are made totally or in part from overseas. The commercials that bring us the game are largely from global companies selling globally. If the commercials are animated, the odds are that the animations, at least in part, were not done in this country. A few of the players were born outside of the fifty states. Much of the clothing worn at the game and a good bit of the clothing worn by the larger electronic audience was produced overseas. One quickly recognizes that if America’s most iconic event, the Super Bowl, has gone global, so has most of the rest of our lives. Shouldn’t our investments recognize that we live in One World? (One World is the name of the book written by Wendell Willkie summarizing his thinking after his defeated presidential campaign against FDR. My mother was one of his assistants.)
The next-to-last financial crisis that faced this country was when Russia defaulted on its own treasury paper. This sent Long Term Capital Management, a very large, professional hedge fund managed by Nobel Prize winning economists and formerly brilliant traders, into a tail spin that threatened other Wall Street participants with similar holdings. The real damage was not done by the Russian default, but by the frantic urge to sell other emerging market debt to raise capital to avoid bankruptcy driven by margin calls. The rapid selling of other government debt and some equity was contagion, as particularly Latin American and Southeastern Asian markets collapsed. While there was no economic connection between Russia and Argentina and Thailand, there was a market connection in that some of the same owners panicked.
This weekend, while watching the football battle in south Florida, there is another financial battle occurring. The question at the moment is whether the government workers in Greece and Portugal will strike over wage cuts and lay offs that were designed to prevent sovereign defaults. Why should we care if Greece goes down? After all, it has been reported that Greece has been in default 105 years of its 200 year history as a modern nation. Throw Greece, Portugal, Spain, Ireland and Latvia together, they are smaller than one of our states, California. (For the sake of brevity I will ignore the dangerous combination that high government debt and large government work force has on the long term health of an economy.) If these are relatively small national economies, why are the various stock and bond markets around the world nervous and pausing during the slow recovery that is underway?
Is the pause just a reaction to the financial and business press? I don’t think so. I do not see recognition on the part of regulators or legislators as to the critical connection of potential foreign losses and the domestic economy. The connection that eludes most of these non-business politicians is the type of loans that are currently in use. With the exception of mortgage loans, most loans in the United States for individuals and businesses, particularly small businesses, are “call loans.” Like margin debt, these loans can be called for immediate repayment, without cause. Simply, the bank or broker wants its money back. (Only the large and /or public entities can borrow on a fixed term basis.) If the banks or brokers believe that they will sustain large losses in their foreign loan books, they will search for capital from all of their sources. Thus, I believe there is a fear that problems on the streets of Athens or Lisbon could cause problems for the Main Street borrowers in Baltimore, Cleveland and Denver as well as smaller towns.
As much as we would like to be isolated from problems, particularly from those generated beyond our borders, we can not. The Super Bowl can not be a purely domestic game; in reality neither can our own financial posture be without foreign perspective. As with many nervous, I would say prudent, investors, we keep our reserves in US Treasuries directly or through money market funds. We have been trained that these are the most secure of all investments. However, it would be naïve on my part not to recognize that foreigners, particularly their central banks, are very important participants in the markets for US Government paper of all sorts. Thus, to some extent, this most domestic of all securities investments is, in reality, globally influenced paper.
The segmentation of investments into international (ex-US) and domestic is the favored technique of consultants and brokers. At one point in time the differences between these two general classes were real and there was major difference in their performance. Today it is less true and will probably be an artifact in the future. While we will continue to report to our investment management clients the way they are used to seeing reports (bifurcating US and non-US investments), my thinking is evolving beyond those distinctions. First, I tend to look at who are the major buyers of various securities, e.g. international institutions, domestic institutions, wealthy domestic families, or the general public served by brokerage firms. Second, where is the source of expected earnings growth? Third, what is the nature of law and regulation governing the securities and their issuers?
I would be pleased to discuss this different way of looking at your portfolio.