HSBC’s most recent Purchasing Managers’ Index (PMI) for the Chinese economy rose to 50.5 from a final reading of 50.2 in August. The manufacturing sector may be expanding, but the growth is noticeably restrained. Meanwhile, German factories registered their slowest growth in 15 months and the French manufacturing segment continues to shrink. Equally disconcerting, the Japanese economy declined at its worst annual rate since the mayhem of the global credit crisis in the first quarter of 2009.
Perhaps ironically, some investors anticipate great things out of European and Japanese stocks. The premise? Both the European Central Bank (ECB) as well as the Bank of Japan (BOJ) are likely to provide the kind of monetary stimulus that pushed U.S. equities to all-time record highs. The problem with this supposition? Respective governments are not quite as likely to overcome structural economic weaknesses; that is, creating money to purchase assets, manipulate rates and depreciate currency value might not be successful in sidestepping recessions in Europe or Japan.
China presents yet another challenge. The probability that the Chinese economy is holding up better than the above-mentioned heavyweights might actually reduce the likelihood of the People’s Bank Of China (PBOC) joining the stimulus party. Nevertheless, attractive valuations for Asian stocks should offset economic uncertainty. That’s why I continue to recommend an allocation to Asia through ETFs like iShares MSCI Asia ex Japan (AAXJ).
Those who have held AAXJ since February might wish to manage downside risk with stop-limit orders; a stop near a price point of 60 might be your unemotional sell point. Others who prefer to employ 200-day moving averages could reduce exposure if the price of AAXJ falls below and stays below its key trendline.
How might global economic uncertainty affect U.S. stocks in the months ahead? From my vantage point, you should have already reduced or eliminated U.S. small-caps from your basket. What’s more, you should diversify the risk of your large-cap holdings with long-dated U.S bond ETFs. I have maintained this barbell dynamic throughout 2014, using funds like Vanguard Long-Term Bond (BLV) and Vanguard Extended Duration (EDV) to offset pullback concerns for core holdings such as iShares S&P 500 (IVV) and iShares S&P 100 (OEF). If you believe (as I have believed since the start of the year) that longer-maturity U.S. yields would not rise due to a weakening world economy, then you might see the value of BLV or EDV in your portfolio.