Sunday, June 14, 2009

Size Vs. Growth

There's something important I want to take a minute to discuss. When I speak with people about the United States falling and emerging markets rising, I think people in their minds look at absolute extremes.

When I say that the United States is falling, I do not mean that we will be driving on dirt roads, riding bicycles, and eating rice every night for dinner. I just mean that it will fall tremendously from our position at the top. Let me try to explain:

Lets say that the United States economy is represented as a number. Right now we have the world's largest economy so we'll say that we are worth 9,000 points. Our economy is far, far, ahead of where China, Brazil, and India are right now. In most of the areas within those countries they are driving on dirt roads, riding bicycles, and eating rice paddies.

We'll estimate that China today is worth 2,500 points. So lets say that the United States continues on the direction that it is currently on, which is losing economic power, and that it falls in value from 9,000 to 7,000 points. Lets say that China continues on the direction that it is currently on, which is gaining economic power, and it doubles in value from 2,500 points to 5,000.

When this happens the United States is now worth 7,000 points and China is worth 5,000. The United States is still larger and more powerful than China in economic terms. I am not trying to dispute that point here, the United States will not live off of rice paddies tomorrow, or even next week.

If you are deciding on a country to live in over the next five years (assuming that a similar scenario takes place), there is a strong argument to live in America because of its continued economic dominance.

But what about where to invest your money?

Lets say that you are looking out 5 years and you want to invest $500,000 of your retirement money. You will hear from everyone you talk to that the United States is the best place to invest because it is the largest economy in the world and it will still have the largest economy 5 years from now.

So you take $500,000 and invest it in the DOW today which is currently around 9,000.

Another investor looks at markets a little differently. He decides to take his $500,000 and invest it in China, which today is a far smaller economy than the United States. Their Shanghai index today is currently around 2,500. (Both 9,000 DOW and 2,500 Shanghai are real numbers)

We come back to see these investors five years from now.

The first one is very proud. The country he invested in is still the largest and most powerful in the world. He is currently holding 7,000 points. He goes and talks to the second investor who now holds 5,000 points. He tells him he made a mistake because 7,000 is worth far more than 5,000.

But what happened to their money?

Investor 1: 9,000 down to 7,000 = $500,000 down to $385,000

Investor 2: 2,500 up to 5,000 = $500,000 up to $1,000,000.

As you can see when you are investing all that matters is the direction we go from TODAY.

I know this is a simple concept but I think its one that investors have trouble understanding. The same concept applies to real estate, bonds, currencies, everything.

The question you have to ask yourself is whether the United States economy will expand or contract over the next five years. If you think it will expand, do you think it will do so faster than other countries around the world.

As you know, I believe many emerging markets around the world will far, far, outpace the United States over the next five years. I will continue to discuss the many reasons for this belief as we move forward through this exciting time.

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