Last week, this column discussed diversification by market sector. This week, we take the Indian investment show on the road and recognize that Wall Street is connected to the whole world.
Every modern economy has at least one stock exchange; the more modern the economy, the more highly regulated the market will be in terms of preventing fraud. It’s a measure of the strength of the U.S. economy that it supports several stock exchanges: the New York Stock Exchange (NYSE, the original “Wall Street”) the NASDAQ (created by and for tech enterprises, but now much broader), and the American Stock Exchange (AMEX) are the major players, but there are many minor players involving not only stocks, but most anything bought and sold regularly: commodities, currencies, politicians (no kidding—the Iowa Electronic Market organizes wagers on the fortunes of pols, among other public events).
U.S. penny stocks – shares selling under $5 that can’t qualify for listing on one of the major exchanges – are traded on the “pink sheets,” so-called OTC markets that, contrary to propaganda, do not stand for “open, transparent, and connected” but rather for the fact that they exist primarily in cyberspace and so you are really buying “over the counter” rather than from a tightly regulated exchange with massive liquidity. I have traded stocks on the pink sheets, but only as wild speculation, too much of which is hazardous to your financial health.
Stock exchanges in other countries are important even if you don’t trade on them. Some discount brokerages offer access to foreign exchanges, but the primary interest in the foreign exchanges for most of us is what they tell us about financial trends coming our way or spreading from the U.S. When we see, overnight, declines in all the major exchanges, we usually see declines in U.S. shares in after-hours trading and we can usually anticipate a dip when the U.S. markets open.
A dip at the open is a great time to go shopping by setting limit orders (conditional purchase orders at the price you wish to pay) substantially below the prices at the bell the previous day.
You can predict an opening dip by watching business reports circle the globe. Like the U.S. market being roughly represented by the Dow Jones or S&P averages, so the health of foreign markets are reported by averages. If the Shanghai Composite (China), the Hang Seng (Hong Kong), the Nikkei (Japan), the CAC (France), the DAX (Germany) and the FTSE (UK, pronounced “footsie”) all trend down, the fact that we are part of a globalized economy predicts that U.S. markets will open down.
Still, the world’s markets are not all the same. Just as the U.S. economy contains both California and Mississippi, the economies of the world come in shades of prosperity and despair, and the business opportunities offered by both.
There are two ways to invest in the world if you do not have access to foreign exchanges, or at least none in addition to the TSX (Canada, the Toronto Stock exchange) and the BMV (Mexico, Bolsa Mexicana de Valores, aka “the Bolsa”).
The first way is by geographical ETFs, starting with those that reflect a selection of all stocks outside the U.S. (GWL, VEU). Most developed countries have their own ETFs, tracking their biggest domestic businesses. I have owned, at times, ETFs dedicated to Canada (EWC) and India (EPI). Some countries have multiple ETFs, and I will focus on Canada to break down for the convenience of our readers in the First Nations.
In addition to the TSX tracked by EWC, you could invest in Canadian small businesses (EWCS), energy companies (ENV) if you don’t mind the tar sands, or bonds (CAD). There is even an ETF dedicated to Canadian preferred stocks (CNPF), which includes several preferred issues by Enbridge, a major tar sands player.
Then there are regional ETFs. For example, Latin America (ILF, EEML, FLN), Europe (FEU, FEP, IEUR, IEV), Asia (AZIA, AIA, ADRA) and Africa (AFK). Within regions, there is more slicing and dicing along the lines I just discussed for Canada: bond funds, energy funds, financial funds, small cap or large cap funds, and also sub-regions, such as Nordic (GXF) or Middle East (MES, FEFN, GAF, GULF).
The symbol for the Middle East Dividend Fund, GULF, reminds me to point out a matter of Wall Street local color. Some funds, like GULF, reach out for cute ticker symbols. Other examples would be agriculture stocks (VEGI and MOO), wind energy (FAN), gold miners (RING), and electrical transmission (GRID).
Another way to divide the world is by more and less advanced economies. The earlier a country’s economy is in the development process, the greater the opportunity for profit and the higher the risk. You have read this before in these columns and you will see it regularly: high gain requires high risk.
Riskiest of all are “frontier markets.” An ETF focused on those countries (FM) has recently taken a major dive. Why? Regional exposure is almost half Middle East. The only country holdings in the double digits are Kuwait, United Arab Emirates and Qatar, followed by Nigeria and Pakistan. Business has not been good in those neighborhoods lately, excepting arms dealers.
So-called “emerging markets” are supposed to represent the sweet spot where high profit potential coincides with minimum risk, the primary risks being political—businesses nationalized, wars, military coups d’ etat, defaults on public debt, and general corruption. This idea of “political risk” is usually minimal in advanced economies, which is why the US credit rating went down when the Republican Party refused to raise the debt ceiling briefly and some Republican politicians were claiming default would be “no big deal.” Mr. Market begged to differ.
The leading horses in the emerging market stampede are the BRIC nations—Brazil, Russia, India, and China. I did not join the BRIC rush because I will not invest in Russia or China. This is not because of political animosity from the Cold War. I abstain from Russia and China because they do not have a reliable rule of law, and when you cannot get a contract enforced in court without knowing important people—in Russia, crony capitalists and, in China, Communist Party big shots—your money is not safe. Brazil and India have corruption, but corruption represents a scandal rather than business as usual. There are ETFs that cover the four leading emerging markets (EEB, BKF, BIK), but it appears nobody has been cute enough to register BRIC as a ticker symbol.
In all ETFs, you need to focus on more practical matters than cute names. What stocks are in the basket? How many shares are outstanding and what is the average trading volume? (The concern here is liquidity, without which your money can get trapped beyond your reach.) Is it passively or actively managed, and at what expense ratio? (Passively managed funds aim to reflect their underlying index; actively managed funds aim to beat it.) How closely has the ETF tracked its underlying index and does it trade at a premium or a discount to NAV (“net asset value”; the market value of the stocks in the basket). As with individual stocks, you need to understand what you own.
If this all seems too complicated, the next column in this series, if reader demand continues, will focus on how to do ETF investing while avoiding the heavy lifting.