Rate cut signals move abroad

by Stephen Butler

I guess Alan Greenspan wasn't wearing clothes after all. Comparing what he claims in his new book with his actual behavior during his tenure as chairman of the Federal Reserve, anyone could agree that he was "one of the biggest political hacks in Washington."

Well, enough name-calling. The problem (or opportunity) we have now is the struggle of the Fed to balance the conflicting interests of a strong dollar against the threat of a credit meltdown. What does it mean for us as investors?

In simple terms, the Federal Reserve is reducing interest rates so that people whose adjustable-rate mortgages come up for renewal will have them reset at a lower rate than would otherwise have been the case. It won't be much lower, but at least it will help.

The other side of the coin has to do with fighting inflation so that our dollar will remain strong relative to other currencies.

This is important because we borrow (or roll over) $2 billion of new government debt every day to finance a debt that largely didn't exist six years ago. If the dollar keeps weakening, aided by the Fed's role in decreasing interest rates, it will take much higher interest rates eventually to attract foreign lenders.

At that point, the Fed will be helplessly swept along by the tide of economic forces carrying the rest of us with it.

Bob Woodward, in his book "Maestro" about Alan Greenspan, pointed out that any Federal Reserve chairman is "really more of a figurehead -- like Princess Diana." Which means that they really serve to inspire confidence and manage public perception rather than exercising the ability to control the economic environment.

The "law of unintended consequences" reigns supreme. This latest effort reminds me more of someone throwing a punch at "Oofty Goofty." In fact, the No. 2 business book on the best-seller list today is "The Black Swan" by Nassim Nicholas Taleb -- a convincing argument that debunks the myths about economic forecasting.

What does it mean for the rest of us? Given that the dollar is now at an all-time low against the euro, probably our mix of investments should lean toward more foreign exposure.

If you look at a chart of just about any foreign fund, the trend line goes almost straight up since mid-2001. This was a full two years before our own stock market began dispensing its magnificent rewards.

How "up" is straight up? T. Rowe Price Emerging Markets Stock is up 40 percent per year for the past three years and 31 percent per year, on average, for the past five years. Vanguard Emerging Markets Index fund is up 37 percent per year for three years and 39 percent for five years. $1,000 compounding at 40 percent per year accumulates to $5,500 in five years.

Stodgy old Dodge and Cox International, investing in huge value-oriented foreign companies, is up 26 percent per year for three years and 23 percent for five years. Even the T. Rowe Price Emerging Markets Bond fund has earned 15.6 percent, on average, for three years and 16 percent per year for five years.

The various computerized financial planning programs, such as Advisor Software in Lafayette, have been steadily increasing their recommendations to allocate more assets toward overseas investments.

The various trade journals for the financial advisory industry have kept up a steady drumbeat along these lines. Some articles have recommended that as much as 50 percent of anyone's equity (stock) mutual funds be allocated to those with overseas assets.

If you're invested in large-company domestic mutual funds today, all is not lost. Most large American companies receive about one-third of their revenue from overseas sales. Before making any drastic moves, or feeling like you've missed the boat, you can punch the "snooze" button and at least know that your assets are not subject to the manipulated (i.e., crooked) stock markets that plague emerging countries.

To accurately second-guess what may happen next is not a reasonable expectation for any of us.

Moving toward more foreign investments makes sense to me, but I'm doing it with eyes wide open to the volatility that it introduces, and I'm holding on to my hat -- something "no-clothes" Mr. Greenspan probably wishes he had thought to do.

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