Friday, October 5, 2007

De-Coupling Appears to be Well Underway, But How Secure Is It?

The issue of de-coupling of the world economies from the US economy appears to be well underway, from the WSJ. The real question is as the US economy continues to slow, what will be the effect on the economies outside the US. This is the true measure of de-coupling. None the less, if the US economy weakens considerably as many anticipate, de-coupling will be fairly complete within five years. Other countries will develop other trading relationships and other currencies will become dominant in response to the weakness of the US economy.

Any investors putting money on the "great decoupling" should know one thing: They aren't the only ones laying down chips.

It's increasingly clear that the U.S. isn't any longer the sole engine of global growth -- that other economies have, in effect, decoupled from it. Witness current events: The U.S. economy is getting buffeted by the housing downturn, but so far the world economy seems to be in fine fettle.

There are plenty of reasons. In Europe, economic overhaul, the adjustment to the adoption of the euro and the process of integrating the old East Germany into the German economy may have finally paid off, putting an end to the long era of subpar growth.

In China, the rise of a consumer class means its rapidly growing economy is no longer as dependent on exports. Even Japan has held up well, which is pretty impressive after its scandal-ridden government told households it had lost 64 million national pension records.

Among the signs that other countries are weathering the U.S. weakness: Oil prices are high -- and not just in dollar terms -- signaling strong global demand. The Baltic Dry Exchange index, which measures shipping costs for bulk commodities, is at a record high, indicating global demand for things like coal and iron ore remains healthy. Seoul's stock market, a proxy for global growth because of South Korean firms' export role, has been surging: The Korea Composite Stock Price Index is up 40% this year. Finally, the dollar's weakness may be a sign of better times overseas.

For U.S. investors looking to cut exposure to a weaker U.S. economy, the key is to find companies that benefit from global growth and avoid those that are domestically focused or have big exposures to the housing market.

Strong global demand makes energy and basic-materials companies obvious bets, particularly since oil and raw materials are good hedges against a weakening dollar. Industrial companies with big overseas sales, such as Boeing and Deere, also make sense, as do most technology firms.

On the other side of the ledger, department stores, media companies, restaurants and other so-called consumer-discretionary companies could get hurt by a slowdown in consumer spending at the same time that they see some of their costs driven higher by the global boom. Many regional banks and other financial companies are getting hit by mortgage trouble. Firms with exposure to housing (builders, building-supply companies) are in the worst straits.

Perhaps the biggest problem with all this is that plenty of people have already thought of it: If you tried to lift a stack of all the Wall Street reports that mentioned "decoupling" in the past few months, your back could be in trouble.

In fact, the share prices of companies with the biggest overseas exposure have been among the best performers lately.

There's a big hidden risk here. When so many investors place bets on the same idea -- no matter how good it is -- even the slightest bit of unexpected bad news can inflict widespread pain as everyone tries to unwind those trades.

The question that the author is asking is if the economies outside the US begin to weaken in response to a weakening US economy, will everyone head for the exit at one time. This is the $64,000 question isn’t it. What is your bet?

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