The U.K. might be the most comfortable foreign country for U.S. investors. But like the U.S., the U.K. has had to endure market cycles that investors should be wary of. The current global slowdown started in the financial sector. The distorted yield curve warned well in advance that trouble was coming, and anyone heeding that warning has missed some of this pain. The yield curve inverts every so often, and for my money, that signals trouble. When this occurs I want to reduce financial exposure, which requires looking under the hood of any broad-based products you own. Consider iShares UK Index Fund ( EWU). EWU currently has a 23% weight to financials, down from 29%, according to my best estimate. U.K. banks have generally felt the same pain as those in the U.S., creating a big drag in the U.K. market. This is not unusual given that many markets have a large weighting in financials, a drawback for many country funds. Given the heavy weighting in financials, EWU has become a less than ideal way for investors to access the U.K. Just as in the U.S., staples and health care are often good places to overweight in a bear market decline. For example, see the chart below of EWU against GlaxoSmithkline ( GSK) (GSK).
Despite a rough go for GSK in January, when the correlation was quite high, GSK has done what an investor might have hoped for over the course of the entire year, offering investors a good place to hide during the current downtrend.
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At certain points in a normal stock market cycle, sector weighting becomes very important, as has been the case on this go-around. If you believe more shoes will drop in the current financial sector, it would make sense to reduce financial sector exposure in your portfolio if you have not already done so. I am not suggesting zero weight but rather underweight. I am currently at about 10% vs. the S&P 500's 14%. Looking forward, the unwind will end and financial stocks will bounce back. You can decide for yourself just when that bounce will come but when it does, EWU will likely do very well at that time, probably leaving GSK well behind. Another way into the U.K. and accessing a bounce in foreign financial stocks might be in PowerShares International Listed Private Equity ( PFP). I have been critical of the fund in the past because I think it really is just a proxy for financial stocks. Since its inception last fall, PFP has tracked very closely to EWU, but given its extreme weight to financials, I believe it will outperform whenever the bounce comes. From where I sit now, financials are not the place to be, but part of portfolio management involves looking forward and realizing that at some point a down-and-out sector will lead again. Think about this now, so you can act later.