Answer To A Reader Queston

On yesterday's post a reader asked;

You have indicated that you do not like broad based indices like the EFA which has high exposure to Japan and questioned why one would want exposure to this country.

Question for you: Do you believe that the markets have priced all known public knowledge and that it is quite challenging to forecast the future? If so, why would you now want to invest in a broad based fund? If not, how can you forecast the unknown and make a determination to avoid a country like Japan, amongst others?

I have never been 100% on board with efficient market hypothesis. The market usually is right it seems but when it is wrong it coincides with declines of biblical proportions (I said pretty much this exact thing on GreenFaucet on Thursday).

In the comment the reader says nothing about forward looking analysis. Do he do any? Do he believe in forward looking analysis? Not being a wise guy, I don't think passive investors who use broad based products do forward looking analysis and they do fine most of the time except in years like 2008.

The reader mentions "forecast the future." That is not how I look at it. You do an anlaysis, draw a conclusion, know not every conclusion can be correct and be prepared to take action when you are wrong.

Back to broad based foreign products; Japan has an inordinate amount of debt. It has more than the US, in terms of GDP. We produce a big chunk of our resource needs, Japan essentially none.

The details and prospects for big Western Europe aren't any better. It may be worse than the US. Looking forward it is difficult to build a strong case for going heavy in these places. On the other hand I can build a very good case for many other countries.

The issue then becomes whether my opinion about the countries I favor will turn out to be correct or not (bigger picture or course the question is does country selection work, and I believe it does). It either will or it won't. Thus far the countries I favor have done better. That will either continue or it won't.

Understand that in trying to build a diversified portfolio I am trying to emphasize countries with different fundamental attributes than the US. It is those countries that give the better chance of a zigzag effect which is what I think diversification is all about. Following that line of thinking a lot of exposure to Western Europe is not called for and the way I think of things Japan would be out too. I will say that I am intrigued by a couple of the railway stocks in Japan have not bought any.

I have been writing about the same general mix of countries for years. They include China, Chile, Brazil, Australia, Norway and Canada. Each has attributes that are generally different from the US but none are risk free either. I'm sure they will continue to have different economic attributes for decades to come. This may not always lead to better investment results but for most of the current decade it has meant better results and I think that will continue for a little while. I do have a little bit of exposure to Western Europe but less than I did a year or two ago. I blogged in the past about selling BP a couple of years ago, selling Barclays (BCS) in December 2007, and I think I mentioned selling Telefonica (TEF) when I swapped into China Mobile (CHL).

At some point most of the things that appear to be rotten investments today will become attractive again. Obviously I hope to be able to generally figure that out and like anyone who invests at the country level I'll either get it right or not but either way at some point Western Europe becomes attractive and maybe even Japan.

Over the last few years the difference in returns available by seeking out specific countries has been dramatic but I also think it is been fairly easy to spot. I know that some investors will never invest down to the county level, I know their argument, I just don't agree with it.