This coming Friday, we are planning to release the January issue of SMI, which will include our new 2015 stock and bond category allocations. One of the big themes you'll see discussed is the strengthening deflationary pulse that has reverberated through the world economy this past year. This has specific implications for our allocation decisions, particularly in terms of our foreign vs. domestic stock allocations.
Without giving the whole thing away, we're reducing our foreign exposure a bit for 2015. Not a lot, because we're already near the lower edge of the range where we still have some diversification benefit (we had as much as 28% allocated to foreign as recently as 2010). There are also a couple of factors discussed that make us think foreign may have some upside next year.
All of this was on my mind as I read this morning's financial bombshell: Russia raised interest rates from 10.5% to 17% overnight in a bid to prop up the value of the ruble, which has been falling fast. If you've been at this a long time, you may be feeling a twinge of deja vu, as plunging oil prices and a strengthening dollar were primary factors the last time emerging markets imploded back in 1997-98. Seeing Russia taking drastic steps to defend their currency faintly echoes their debt default in that earlier period. Obviously this isn't as drastic, but it does heighten the anxiety over what may be in store for some of these emerging markets if current trends are maintained.
As you would expect, I spent some time analyzing this within the context of the new 2015 allocations and our rationale for them. Are we correctly balancing the risk/reward? Should we have been more conservative?
Most of these questions can really only be answered with the benefit of hindsight. But it did bring to mind something that we don't stress much, but perhaps should. When we issue guidelines — like these allocations for next year — we always assume that each reader is going to apply those within their own personal framework of risk tolerance, etc. Of course, we try to craft them in such a way that customization isn't required: we know that most readers want to be able to take our recommendations and run with them without any extra work involved. But there are a number of places where our general guidelines can be tailored based on an individual's desires.
This foreign/domestic allocation for 2015 is a good example. There's a risk based on what we're discussing today (and what's written in the commentary you'll receive Friday) that foreign stocks could get hit next year. If there's a full-blown crisis in the emerging markets, we'll probably all wish we'd avoided foreign stocks completely. If that's something that you're especially concerned about, or if you just want to dial down that particular risk in your portfolio next year, it's okay for an individual to say, "You know what, SMI is recommending X% in Foreign stocks next year, but I think I'm going to do less than that."
Naturally, we wouldn't be recommending that Foreign allocation if we didn't think the risk/reward favored having some money allocated there. But you're always free to adjust, as long as you understand the implications of those actions. In this case, you'd be foregoing the potential benefit if foreign stocks perform better than expected next year. There's also a bit of diversification benefit you might be passing on. But overall, lowering your foreign exposure would likely reduce your overall portfolio risk.
I'm not trying to encourage anyone to make this specific change, nor am I really trying to encourage tinkering with the SMI systems to any great extent. I was just thinking about this specific issue today in light of the morning's news and thought it might be worth pointing out that there is some built-in ability to tailor our general recommendations to your specific circumstances. If something seems risky to you and you'd rather avoid a particular risk, there's generally a reasonable way to do so. It's not our way or the highway. We give you the tools and information you need to craft a plan that works for you.