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We all have seen how quickly an ideal political scenario can sour, and vice versa In an extreme case, political upheaval can wipe out an entire portfolio Anyone who happened to be fully invested in Chile when Salvador Allende began nationalizing major industries in 1971 could have lost everything But this scenario is rare and easily avoidable Throughout this book, I have stressed the benefits of individual security selection: a bottom-up, company-by-company approach to investing worldwide So why even address political risks Do political considerations even matter for an investor who focuses on individual business fundamentals and builds a well-diversified portfolio In short, yes to a degree Consider how concerns of an economic crisis surfaced in Brazil in 2002 as the country s unemployment rate spiked and the inflation rate surpassed 20 percent in neighboring Argentina Its debt crisis also raised fears of a contagion spreading across Latin American economies But it was in the political arena that many investors raised the most serious doubts about the countries By July of 2002, investors were voicing concerns over the presidential election polls that showed a lead for left-wing candidate Luiz Inacio Lula da Silva While outgoing President Fernando Henrique Cardoso s government paid careful attention to the market, da Silva s social issue I believe one of the best agenda left many worrying about defenses against political the country s debt obligations and risk is diversification economic health As da Silva s
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UNIQUE ASPECTS OF GLOBAL INVESTING
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lead in the polls widened prior to October s election, Brazil s stock market tumbled In the third quarter alone, the market lost 394 percent, as measured by the MSCI Brazil Index Investors fled in hopes of averting a political and economic crisis, citing:
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The country s debt had ballooned to $260 billion Brazil s inflation rate reached an 8-year high, and its currency lost 40 percent against the US dollar at one point in 2002 Both da Silva and a fellow left-wing candidate stretched their lead over the government-backed candidate The Central Bank of Brazil failed to place all of the public debt offered during the summer of 2002 Brazil s debt rating was downgraded by Moody s Investor Service on June 4, 2002; by Fitch on June 20, 2002; and by Standard & Poor s on July 2, 20021 Brazil more than doubled its inflation target for 2003 and 2004
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While the headlines focused on dramatic scenarios, investors who carefully weighed the factors could see several hints of opportunity For instance:
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Brazil s companies were largely insulated from Argentina According to Bloomberg, they sold $5 billion of goods to their neighbor 86 percent of exports, or less than 1 percent of GDP in 2001 Da Silva appointed a Princeton economist with free-market credentials to reassure investors In August, the International Monetary Fund (IMF) announced a $30 billion loan program to Brazil Brazil s economy registered third-quarter GDP growth of 24 percent as the weakened currency helped stimulate exports Brazil posted a consolidated primary budget surplus of 524 billion reals (US$147 billion) for 2002, exceeding the level needed to fulfill the terms of its accord with the International Monetary Fund
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And how did Brazil fare with its political crisis The crisis never seemed to materialize Just months after election, da Silva was lauded by investors around the globe for his commitment to controlling inflation, luring investors and rationality back to Brazil s markets The situation
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LEARNING TO THINK GLOBALLY
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illustrates how markets can suffer even in the absence of an overt political crisis As Fitch noted in its decision to lower the country s credit rating:
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[Our] argument takes into account the country s political transition It is based, therefore, on what might or might not happen In its declaration, however, the agency itself recognized its incapacity to form a judgment regarding the situation
When broader market participants perceive political uncertainty and act impulsively, investors often may find extremely compelling bargains I encourage investors to consider a country s political climate after they ve identified a solid business in a country in which they want to invest I believe an evaluation of political terrain can affect the assessment of a company s underlying business value and help investors decide at what price shares should be purchased When evaluating political risks, the value investor should consider the attitude of opposition political groups, the level of stability in the labor market, the country s economic sensitivity to energy costs, and the government s policies toward foreign investment and private enterprise I also think political factors can influence how large of a position the security should occupy in a well-diversified portfolio I certainly would not suggest an assessment or forecast of a country s political environment as a starting point for individual stock selection I don t believe anyone possesses superior predictive abilities regarding political developments that could produce consistent benefits for investors I believe one of the best defenses against political risk is diversification I suggest limiting investments in a single country to the greater of 20 percent of portfolio assets or 150 percent of that country s weighting in a comparable index I believe this provides both diversification benefits and flexibility By limiting exposure to any one country, only a portion of the total portfolio is exposed to particular political risks In addition, the value investor is a long-term holder of a stock and is willing to endure temporary drops in a country s stock market For example, after the Tiananmen Square massacre in 1989, Hong Kong stocks fell substantially But the ever-patient value investor eventually saw stock prices gradually surpass their original values Some value investors even view political risk in a positive light, since the resulting uncertainty can create good buying opportunities As was the case with Tiananmen Square, political developments can involve tragic consequences I m not suggesting that investors ignore such tragedies or develop a callous nature I am suggesting that in the wake of such occurrences, specu-
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