Market crunch response: Should you globalize your portfolio?

Posted Feb 28th 2007 9:15AM by Peter Cohan
Filed under: Before the Bell, International Markets, Economic Data

Remain calm. The news is mixed in the aftermath of yesterday's global market crunch. The Shanghai market rebounded 4% after yesterday's 9% decline. While other markets around the world tumbled, U.S. futures are suggesting a rebound.

There are three important global forces that I believe will influence the market's medium term direction:

Risk revulsion - This morning's Wall Street Journal [subscription required] reports that investors' attitudes towards risk are changing. Until recently, investors were willing to lend money for leveraged buyouts and to buy securities backed by subprime mortgages. Now, they are selling those securities and buying 10-year Treasury notes. As I posted Monday, loans to finance private equity deals are at a record $480 billion and their default rates are expected to double to 3.07% this year. This new risk aversion will raise the cost of financing these deals

Global market interdependence - As the New York Times [registration required] reports, markets and economies around the world are acutely dependent on each other. This interdependency becomes particularly apparent when markets quake as they did yesterday. For example, many stock markets -- such as Thailand's -- fell because of concern about a U.S. recession which would cut U.S. demand for Thai-manufactured products.
Yen carry trade - According to Bloomberg, the yen carry trade in which traders buy yen and sell the currency to fund higher-yielding investments could have a big impact on the value of the dollar and thus U.S. interest rates. The yen has been considered a good currency to finance higher yielding investments because Japan's 0.5% interest rate is the world's lowest. However, yesterday traders were unwinding their positions because the yen strengthened against the dollar. Today the yen dropped because Japan reported that industrial production and retail sales fell, reducing the likelihood that Japan would raise interest rates to curb inflation. If the carry trade crumbles as it did yesterday, the dollar could weaken and the Fed might need to raise interest rates to prop up the dollar -- further tightening the vise of the credit crunch.

The second force is not going away but the first and third will fluctuate over time. As an investor this means that you need to consider putting a portion of your portfolio in international stock funds. But as yesterday's action suggests, some of these international markets are much more volatile than others. While the internet makes it easier than in the past to trade globally, it also should enable you to educate yourself on these global interdepencies.

For the sake of your family's future, you ought to learn more about them. In the meantime, expect the market to react strongly to reports today on fourth quarter GDP, the purchasing managers' index and Bernanke's congressional testimony.

Peter Cohan is President of Peter S. Cohan & Associates, a management consulting and venture capital firm. He also teaches management at Babson College and edits The Cohan Letter.

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