As we begin looking at our year-end investment portfolios, and feeling a sense of dread as we see our retirement savings down a third or more, it is useful to compare the US markets with the rest of the world. As it turns out, over the last year US investors would have been better off investing more in the US, and less overseas in the "hot" markets, such as China and Brazil (see WSJ article). Just as many investors this year realized that their global exposure was a little lite, the bottom fell out in some of the very same markets they began increasing their exposure in (not to mention drops in the US market - see graphic below from the WSJ).

Source: Wall Street Journal and Thomson Reuters

After rallying nearly 10% over the last week, the DJIA is down "only" 33 percent for the year. In comparison, the Shanghai Composite (China) is down over 64 percent, while the the Bovespa (Brazil) the DAX (Germany) are down over 42 percent. The FTSE 100 (UK) is down about the same as the US DJIA. The Dow Jones World Index, which excludes the US markets, is down 49 percent in dollar terms YTD. Of course, massive sales of foreign stocks by US investors has also not helped international markets. Between July and September, US investors sold $92 billion more of foreign stocks and bonds than they bought during the same time. Therefore, if you recently failed to jump on the international diversification train this year, either because you had foresight, or were simply too confused or too lazy and never got around to it, smile - you could be even worse off this year. If you jumped on board back in 2003, you have experienced a nearly lost half-decade for many markets, but you can also smile - at least you are nearly flat. If you jumped on board in late 2007, or earlier this year, well ........, at least you have your health (and a lot of company to commiserate with).

As recently discussed, the Shanghai Composite has swung from 3,000 to 6,000, and back to 3,000 in a little over a year. To help curb the sell-off, the exchange instituted new rules to restrict large share sales by controlling investors, putting them in a 30-day lockup window, further reducing the amount of new shares and dilution hitting the market. China is now going further by reducing the stamp duty, or stamp tax, charged on share sales. The tax is being lowered from 0.3% to 0.1% in an effort to reduce buying cost, and increase interest in share purchases. Just last May China and the index did just the exact opposite, raising the tax from 0.1% to 0.3% in an effort to cool a market that was beginning to look overheated. Not surprisingly, the market liked the recent move and tax reversal as the Shanghai Composite posted a 9.3% increase during the session after the news, and is now trading above 3,500. In addition to the overall increase, over 200 shares hit the daily 10% limit imposed by the index.

Does the reduction in stamp tax increase trading? Yes, but somewhat indirectly. By paying lower fees, investors have more funds to purchase additional or new securities. One estimate has investors saving 120 billion Yuan over the next year alone, with an expectation that some of these savings will make their way into the market. Of course, with higher return usually comes with higher risk, especially when the move is driven by intervention. As the Shanghai Composite index has just illustrated, both risk and opportunity can come from the same source, but in unexpected ways, and at unexpected times, irrespective of our view of the fundamentals. As a side note, many of us jump into an international index without really knowing what we are investing in. For instance, consider the S&P 500 Index and Nasdaq Composite. Proxies for their markets? Sure. But it is important to know what these markets represent. For the China market, shares of PetroChina represent about 20% of the Shanghai Composite index value. After reducing the stamp tax, and with a little help from oil prices, shares of PetroChina increased 7.1%, contributing a good deal to the move of the index. Being levered more to oil may not be a bad thing, but it is important to make sure we know what is inside the package we are buying, and whether this makes us more or less exposed to a specific sector or industry. Of course, hoping that any expected or unexpected market intervention will be best for our position is something we have a little less control over, even if we “understand” the market.

The Shanghai Composite market fell below 3,000, after rising as high as 6,000 just four months ago. The composite first approached 3,000 in the first quarter of 2007, on its way to over 6,000 in October. The recent sell off has the Chinese stock exchange worried, causing it to include rules that restrict large share sales by controlling investors, thereby reducing the amount of new paper hitting the market. So far, the new rules are having little impact.