Feds bailed out China, not the US

Follow the new leader

Where China goes these days, much of the developing world follows. Other Asian economies that were sacrificing some growth to lower inflation are likely to follow China's lead and more actively pursue growth. That includes India, where the Congress Party faces a tough election in 2009. The Fannie Mae and Freddie Mac takeovers free banks and central banks in these countries, too, because they all owned huge positions in agency debt at the end of 2007 -- $63 billion for South Korea and $55 billion for Taiwan, for example.

All this adds to what was a pretty convincing case to begin with for putting more money into overseas assets. Citigroup (C, news, msgs), for example, recently recommended that U.S. investors put 55% of their money in stocks into overseas stocks. That's a big jump from what was already a big allocation of 30% to overseas stocks. The average U.S. 401(k) has just 7% of its stock assets in overseas equities.

But Citigroup's recommendation does no more than track the percentage of global assets in overseas markets. Non-U.S. stocks now make up about 57% of the Dow Jones Wilshire Global Total Market Index ($DWG). So by moving to a 55% allocation, you're just about matching the current state of global equity markets.

There's more at stake here than some stock-strategy geek's desire to match a global index. Just as an investor will make more money by buying shares of a fast-growing company, in the long run an investor will make more money by buying into the stock markets of countries with faster-growing economies.

The mature economies of the developed world aren't simply growing slowly now because of a temporary economic slowdown. They're likely to grow more slowly over the next decade or more than the economies of countries such as China, India, Russia, Brazil, Vietnam and more. A U.S. investor can capture some of that growth by investing in U.S. companies that sell into those economies. But the biggest gains will come from direct participation in those developing stock markets themselves.

In the long run, these overseas markets aren't any riskier than the U.S. stock market. Over the past 10 years, the standard deviation, a measure of volatility, of the U.S. stock market is 15.4. For overseas markets, it's almost the same: 15.5.

But that's an average for all overseas markets over the long term. In the short term, investors know that some overseas markets, especially the stock markets in developing economies, can be a huge risk.

So far, 2008 hasn't exactly been a great year for U.S. stocks. As of Sept. 9, the Standard & Poor's 500 Index ($INX) was down 17% for the year. But that was great performance compared with the 27% decline in iShares MSCI Brazil (EWZ, news, msgs), the 31% loss for iShares Hong Kong (EWH, news, msgs), the 35% loss for iShares MSCI Korea (EWY, news, msgs) and the 39% loss for Market Vector Russia (RSX, news, msgs). Those are all exchange-traded funds that track the Morgan Stanley Capital International indexes for a particular country.

The old rule of thumb that I learned more than a decade ago seems to hold: Developing stock markets are about twice as volatile as the U.S. market.

Volatility cuts two ways, of course. These stock markets fall twice as fast on the downside and rise twice as fast on the upside. Stock markets in developing economies have big rebound potential after falls of 30% or more.

But just because these markets are down 30% or more doesn't mean they can't fall further. The U.S. stock market is still looking for a bottom, and so are the markets in China, Russia, Brazil and the rest of the developing world.

A question of timing

To time your buys in these markets, I'd look to both external and internal signals. The most important external signal would be a bottom in the U.S. market. It will be hard for the world's more volatile stock markets to move up while the U.S. market is still throwing a scare into investors on a regular basis. Internally, I'd look for signs that growth in China's economy has started to accelerate.

One indicator to look at is Chinese auto sales. Preliminary data showed car sales down 10% in August from the same month in 2007. A turnaround in that decline would show the economy is reaccelerating and would ripple out through other major sectors, such as steel, now showing slowing demand. I'd also look at copper prices. Copper demand is a good indicator of construction activity. Copper prices have fallen in early September to match January 2008 lows, and the metal is selling at 20% below its summer high.

But demand from China may be picking up. Copper futures -- contracts for copper to be delivered in three months -- recently moved to a premium in the Shanghai market over futures prices in the London market. That's the first time since January that Shanghai futures have traded at a premium.

Continued: When you buy

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