Ring A Ring ‘O Roses, A Pocketful Of Posies, Atishoo, Atishoo, All Fall Down!

Japan’s economy is now in technical recession after the shock news that the country’s gross domestic product (GDP) tanked in the last quarter. Expectations were that the economy was growing.
Japan is the world’s third largest economy. This is not good news. The economy contracted by an annualized 1.6 percent. The forecast had been a gain of 2.1 percent. The economy contracted by 7.3 percent in the second quarter. In other words over the last six months the world’s third largest economy is now 8.9 percent smaller. CNBC points out that this is obviously “shockingly weak”.
The Bank of Japan (BOJ) has already increased again its massive stimulus efforts to boost spending and inflation. All to no avail. Japan has the highest level of public debt of all developed nations and the government has imposed new VAT increases to cut debt. At the same time spending and stimulus is aimed at destroying the value of the Yen to boost export competitiveness. The strategy is certainly not new or even vaguely inspired. Inflation (if you can get it) and debasement shifts the burden to lenders and away from indebted governments. Deflation encourages people to delay spending and is difficult to reverse as it requires changing expectations.
And the American government is playing the same little nursery game with their citizens.
Every single American politician will stand up and proclaim that they are in favour of a strong dollar, yet the continuous and orchestrated debasement of the American dollar is one of the most pervasive megatrends of modern times.
Even the Swiss, of all people, have fought to prevent their currency from appreciating by pegging its value to the American dollar. And America wants to introduce punitive sanctions against China because they are of the view that the Renminbi is artificially low. It really is a race to the bottom!
Weighing this trend is most important when formulating investment strategy.
What does one do? Where does one invest?
Well the short answer is equities. Asset allocation is by far the major determinant of returns and equities in a portfolio are a core return generator through dividend and capital appreciation. Shares have, certainly over the last few decades, provided the highest return and inflation protection of all asset classes. Equities, however, especially over the short term also increase portfolio volatility and therefore each investor needs a tailored portfolio taking into account personal circumstances.
Equities cover an immense spectrum.
Small international growth stocks will provide the highest return. Logically it is much easier for a small company to double in size than it would be for a very large company.
Developed market equities and emerging market equities are two other equity segments that provide fertile grounds for search and allocation.
I have already discussed the current deflationary spiral above but another megatrend is the increasing importance of emerging markets. These markets are found in parts of the world that are still rapidly developing. They have a younger and growing population with a rapidly increasing rate of literacy and rising living standards. Again this is an arena where small and growing companies can be found.
By adding these equities to your portfolio you gain a manifestly higher growth profile and the benefit of increased diversification as these markets are negatively correlated to developed markets.
If you want to grow your capital, go where the growth is i.e. where revenue and profit growth is the greatest. The growth of emerging markets is arguably the most important trend of our age.