What to do when the world is falling apart

Things will probably stabilize at some point in the near future, but then a cascade of additional worries will take the markets down again shortly after that before a more permanent bottom is found. That's the typical pattern in these crises and I would be relatively shocked if that didn't happen now.

The fundamental question is then what should be done with one's personal investments? Well, there's little profit in rushing into this market at the moment to find a bottom. There is not a single event that could occur that would right all of the wrongs that ail the market at this point. There is no package that the EU could produce or is likely to produce that would soothe markets. There is no stimulus plan that the U.S. is remotely likely to put forward that would boost growth prospects. There is no sector of the economy that is poised to suddenly burst onto the scene with unexpected vigor and drag the rest of us with it. Political shackles have consigned us to quite difficult time at the moment.

For now, the most prudent thing to keep your current cash reserves and not deploy at this time. Also, any safer investments that hold up well will serve as reserves to take advantage of more speculative plays that get hammered. For instance, Brazil is getting destroyed right now: http://www.marketwatch.com/investing/fund/ewz

Before long, there will be fantastic opportunities. There always are after panics.

Brazil = China? Well, EWZ = FXI

I was browsing the emerging market ETFs and, before I made an explicit comparison between the iShares Brazil ETF (EWZ) and the iShares China ETF (FXI), I said to myself "That chart looks awfully familiar...".

There is a reason for that:

They trade nearly identically. I remember once preferring Brazil over China, and most of the time that has made sense. Brazil's markets have vastly outperformed China's since 2004. However, it appears that since the huge 2008 correction in all emerging market stocks (and all stocks for that matter) these two markets have been locked in a very tight dance. I know that the Brazilian exports to China are one of the primary drivers of economic growth in Brazil, but you would think that differentials in company performance would produce more variance than this. 

A Brief Note on Financial Crises and Safe Harbors

One of the great new contrarian pieces of "knowledge" has been that you can hide from a developed market financial crisis in emerging markets. This was said in 2007 and 2008 when we went into the soup and it was said again this time during the ongoing European financial crisis. Just to show how silly that idea is, here is a chart from June 1, 2008 through March 1, 2009:

The green candlestick line is the S&P 500, the olive line is the FXI from yesterday, the purple line is the iShares MSCI Emerging Markets Index Fund (EEM) and the light blue line is the iShares Brazilian Index Fund (EWZ). As you can see, over this period, the U.S. outperformed all of those markets for the duration of the worst of the crisis.

Similarly, in the current crisis the pattern has been continued:

The pattern is repeated, to varying degrees. So, what is the safe harbor? U.S. Treasuries have been, are, and will likely continue to be the last best hope for investors in the midst of a crisis. I could show the chart from 2008, but that's just beating a dead horse. Here's the most recent performance with the iShares Barclay's 20+ Year Treasury Bond Fund (TLT) represented by the.... I guess that's salmon colored line:

As you can see, long-duration U.S. Treasuries are a good safe harbor for assets in short term financial crises, regardless of whether they are here in the U.S. or if they are in Greece, China, Japan, or wherever else there might be a crisis. That being said, as a long term prospect, I am not thrilled with the outlook for Treasuries at the moment as I have indicated previously. As interest rates rise in the future, you will get slaughtered for a large position in them. In the short run they might be appealing, though even here I'm not sure how much more upside they have. I think we are probably within a couple weeks of the worst of the European crisis being behind us, though it will get ugly before it is over.

Someone may ask "What about gold?". In response I say, "Treasuries > gold" in a crisis. It was true in 2008. It is true now. Gold is only superior in a time of hyperinflation.

Anyway, those are my thoughts.