Diversification - Its Components
In a previous post we discussed different economies being at different stages of economic cycles, at the broadest level the Long-Term Debt Cycle, and the importance of diversification across asset classes. Equally as important is geographic diversification when making Asset Allocation decisions, as elaborated upon in this report by Bridgewater Associates. Their insight: "Differences in macro conditions and the corresponding policy responses and market action are as large as they have been in 40 years."
In effect the trend is a reversal of previously established correlations across the global economy. Across Western developed economies hawkish monetary policy increased discount rates, which are a key component of valuing assets, and reversed the flow of liquidity driving capital from assets to cash. This bearish positioning means there is a lot of capital that could be invested in equity markets. The problem is that the Equity Risk Premium i.e. [The S&P 500 earnings yield - The US10YR yield] remains too low and does not compensate for current tail risks (potential; banking crisis, inflation risks, geopolitical risk) that the market faces.
In contrast, Japan, China, and much of the East are in the opposite stage of the cycle where policy is supporting the flow of money and credit to support growth, discount rates are low and risk premiums are attractive. This divergence and the implications it has on on asset performance is is captured diagrammatically below.
But there are also significant differences across Asia, for example between Japan and China, see here for a good write-up about the differences between Japan and China.
All of sudden Asset Allocation is shaping up to be a very complicated exercise. And we have not, as yet, taken into consideration Africa and a geographically agnostic asset like Bitcoin. More on Africa in future posts. As it relates to Bitcoin, on a risk-adjusted basis, over a relatively short period of time, Bitcoin is generating good returns, relative to other assets i.e. Gold, U.S.Stocks, U.S. Real Estate, Bonds and Emerging Currencies, reference Bitcoins Risk-Adjusted Returns below.
The point: If your goal as an investor is to generate superior risk adjusted returns your foundation is Asset Allocation, which prompts a good understanding of how different asset classes are performing in different parts of the world, that is off-course assuming, that you can easily and cost effectively access different asset classes across different geographies.