Investing Capital in a (Very) Uncertain World
As I see it, there are only two possible outcomes to the mess the Western democracies have gotten themselves into:
1. This is the end of the Western democracies, at least in terms of dominating the world economically, militarily, and culturally. More vigorous nations, such as China, India, Brazil, and Russia, will soon rule the world.
2. The Western nations will, slowly but surely, get their acts together, and we'll be back on solid ground again.
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If you believe in (1), you should invest all your money in emerging market stocks (and bonds) and relax on your back porch while your portfolio rises and the West sinks.
If you believe in (2), as I do, one of three things will happen:
1. The Western governments will eventually take concrete steps to rein in spending and bring down debt. (I can think of this as analogous to Reagan and Volker taming inflation in the early 1980s.) When they do, you should move to a position well above your targets in risk assets.
2. The West will muddle through, never really taking conclusive action, but managing to stave off collapse. In this case, equity multiples will gradually decline into the single digits, at which point you should move to a position above your targets in risk assets.
3. The eurozone will collapse, precipitating a global crisis that will cause equity prices to plunge to levels not seen since the mid-1970s—or maybe the early 1930s. This will be a catastrophe for the world, but will offer investors a once-in-two-lifetimes opportunity to buy stocks at subterranean pricing.
In the meantime, most investors should remain positioned close to their targets in risk assets, because (a) as noted below, equity multiples are not outrageously high, and (b) I could be wrong.
The beauty of the preceding strategies in outcomes (1), (2) and (3) is not that those strategies will maximize your gains, but that they will help preserve your capital until it's possible for significant gains from risky assets to become likely again. And at that point you will have the dry powder required to back the truck up. Optionality matters.
