Finding Tailwinds in Portfolio Construction

By Roger Nusbaum | July 22, 2008 | 1:06 PM | 2 Comments

The notion of finding tailwinds in portfolio construction is a very important concept. Over the last 12 months what would have been more likely, that you find the one financial stock that went up or that you avoided the one commodity stock that went down?

This plays into country and region selection too. One sort of tailwind that can put the odds in your favor is from the 30,000 foot view; where is money going? Who has the money? Who is benefiting from the current environment, why and is it likely to continue?

This line of thought makes a compelling case for the Middle East which is now easily accessible with the WisdomTree Middle East Dividend Fund (NSDQ: GULF) and the PowerShares MENA Frontier Countries Portfolio (NSDQ: PMNA).

Oil makes this region wealthy. You have no doubt read about the largesse of the Sovereign Wealth Funds in this region and they are growing larger as oil stays expensive. Is oil likely to drop? Obviously if oil goes down and stays down that would be an obstacle.

The US uses 25 barrels of oil per capita. China's use has skyrocketed in recent years to two barrels while India per capita use is not quite one barrel. What direction do you think consumption will head in these countries over the next ten years? Will either country use less oil?

This guarantees nothing as the region endured a ghastly decline in the first half of 2006 after an all out mania in 2005. The region will not be immune from future volatility but the region is getting wealthier, they are investing more in their own infrastructure and in the world or put another way the rgion is becoming more globally relevant

A catalyst for potential further gains for US based investors is a potential de-pegging of the currencies in the region. For now most of these countries peg their currencies to the greenback by keeping interest rates artificially low which has created some inflation problems. For now all parties concerned deny there will be a de-pegging but it makes economic sense and if it happens the currencies would likely appreciate which would be an extra benefit to holders of equities. 

The argument against de-pegging is that it would impede the US' ability to afford oil. Well maybe but, again, where is growth in consumption likely to come from?

Again, not riskless as there is volatility and increasing inflation but there is clear and obvious capital flow into the region that seems likely to persist.

It would make sense to keep any allocation to this part of the world at 5% or less which would be enough to add value to a portfolio if it did well but not be ruinous if the next 30% was down.

Interesting. I've put this Interesting. I've put this one on my watch list and will be doing some due diligence. The region could prove to be fairly recession-proof, especially if oil remains above $100, which is likely. Good call Roger. Submitted by Mike Stathis on Tue, 2008/07/22 - 10:34pm » reply |