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My Expected Investment Changes in 2015

I make investment changes at a glacial speed. The last change was about five years ago when I combined micro-cap stocks with small-cap value stocks to reduce the number of funds in the portfolio. Before that, I eliminated a preferred stock allocation, which was fortunately done right before the financial crisis. Over the coming year, I believe the opportunity may present itself for another change.

Currently, 70% of my stock allocation is in US equity and 100% of my bond allocation is in US bonds. Sometime in 2015, I may shift my portfolio to a more global stock and bond allocation.

I can’t say exactly when this will occur. I don’t expect it to be in the near future because certain events have not fully unfolded, but they’re getting close. The US led the world out of a deep global financial crisis that started seven years ago. Bold moves by US Federal Reserve members and government leaders provided the firepower needed to pull the country back from the brink of a depression.

Interest rates were pushed very low, money became abundant through quantitative easing, debts were restructured, the national debt declined, incomes started rising, growth rebounded, unemployment dropped, and inflation was amazingly tame throughout. Many of the moves were unpopular such as bailing out too-big-to-fail financial institutions, but they worked, and the US led the world out of a bad situation.

Unfortunately, the rest of the world didn’t follow very well. Central banks and governments did not provide enough economic stimulus, debts did not decline as quickly, incomes did not advance much, and unemployment remained stubbornly high in some regions. This caused local currency values to decline and some regions slipped right back into a recession.

Equity markets were the great equalizer of all that occurred. Figure 1 shows how different the outcome was in US stocks versus international stocks since 2009.  Shown are the growth of $10,000 in total return in the Vanguard US Total Stock Market ETF (ticker: VTI) and the Vanguard FTSE All-World ex-US ETF (ticker: VEU) for five years ending November 30, 2014.

Figure 1: Vanguard US Total Stock Market ETF versus Vanguard FTSE All-World ex-US ETF

Source: © The Vanguard Group, Inc., used with permission.

Only now are countries and regions such as Japan and the European Union (EU) making the hard choice to re-stimulate their economies through aggressive actions. Japan, EU and even China are pushing interest rates lower and boosting the money supply through central bank purchases of assets. It’s essentially what they did during the financial crisis, but they took their foot off the pedal too early.

You may be asking, why should stimulus work this time since it has been done before and didn’t work? In my opinion, the difference this time is a steep drop in commodity prices, particularly the price of oil. A 50% drop in petro has provided a much needed shot in the arm to energy importing countries and regions: Japan, Eastern Europe, China, India, etc. It’s this huge dividend that makes the difference.

Those countries paying the dividend aren’t happy though. Commodity exporting countries such as Brazil, Russia and Venezuela have seen their currencies shrivel, debt prices collapse, and a loss of investment capital from all sources. This has had a crushing effect on their stock markets.

I mentioned earlier that I’m waiting to make a move into more international exposure. What might that be? The second shoe to drop is called a sovereign default. It’s the failure or refusal of the government of a sovereign state to pay back its debt in full.

We’ve seen dozens of sovereign debt defaults throughout history. There have even been a few US government defaults. Carmen Reinhart and Kenneth Rogoff remind us in This Time Is Different: Eight Centuries of Financial Folly of the unending cycle of boom and busts that start with excessive leverage and over-investment. This leads to the inability to pay debt, a default and then a financial crisis. This is followed by a restructuring, economic stability, credit expansion and growth.

Fresh on our minds is Greece. The country defaulted in 1932 and again in 2012. The Athens Composite Share Price Index fell over 80% between 2007 and 2012. Greek stocks staged a strong recovery in 2013 after the default and debt reconstruction. Those in power vow never to allow their countries to be in that situation again, but they eventually leave office or die and the cycle renews itself.

I believe the tailspin in commodity prices lays the foundation for a fresh round of emerging country defaults. It will hit oil exporting countries the hardest such as Russia, Venezuela and several Middle East countries whose governments are already unstable. If these defaults do occur, there will be temporary contagion in all emerging markets similar to the Russian default in 1998.

This is what I’m waiting for. The global media hyped around a sovereign debt default or two will present long-term investors an opportunity to re-align their portfolio allocation to something more global-like and less US-like. This isn’t to say I’m bearish on the US. This shift just puts my portfolio closer to a global market allocation, which is where I want it to be during the second half of this decade.

I talked about over-allocating to the US during several recorded Portfolio Solutions client conference calls in 2009 and 2010. At the time, I believed the US would lead the rest of the world out of the global financial crisis, and I guessed right. Now I’m planning a move toward a neutral global mix. I believe the opportunities outside the US are at least as good as inside, and I’ll probably be adjusting my portfolio in the next year to reflect this belief.