1. An investor’s choice of asset allocation is the single largest factor that will influence the probability of long-term success. Historical evidence suggests that cash investments return the least amount over the long run.
2. There is significant upside potential in equities for long-term investors right now. Stock valuations are well below their highs and have a long way to go to be back in line with what we consider to be fair value.
3. Sustained low interest rates and dramatic increases in money supply combined with increased deficits have many fearful of the inflationary impact once a true economic recovery takes hold.
   Money market investments, non-market linked CD’s and high interest savings accounts offer little protection against the wealth eroding effect of inflation.

That is not to say that there is no downside.  In fact, there is an inherent risk when investing in equities and there may, in fact, be another leg down.

However, I believe the risk vs. reward payoff  favors the astute dividend growth stock investor at this time.

Increasing Importance of Global Diversification

The importance of global diversification and how most future growth is expected to come from U.S. and international markets, in particular Emerging Markets is not a new idea. MGI’s report however, outlines some additional new insights into the world’s major cities’ current contributions to global growth and where it’s likely to come from in the future.

Below are some key pieces of data form the report that are most relevant:

• Contrary to common perception, MGI found that the world’s largest cities have not been driving global growth for the past 15 years, and many have not grown faster than their host economies. Its estimated that today’s 23 largest urban areas will contribute just over 10% of global growth to 2025, below their current 14% share of global gross domestic product (GDP) today.
• Middleweight cities in emerging markets are poised to delivery nearly 40% of global growth by 2025, more than the entire developed world and emerging market megacities combined
  (middleweight is defined as metropolitan areas with between 150 thousand to 10 million inhabitants and megacities have 10 million or more).
• Currently, 1.5 billion people live in the top 600 urban centers of the world and account for $30 trillion or more than half of the world’s GDP. It’s expected that by 2025 the population in these cities will reach 2 billion and will account for $64 trillion or more than 60% of the world’s GDP.

Again, the importance of global diversification of investments is not new.  However, this report gives some merit to paying additional attention to the growth of centres outside of the major metropolitan areas in the emerging economies.

What does this mean for you as an investor?

Of course, the situation in Greece has been front page news this week and it has created some choppy waters for investors (it was another volatile day on the markets yesterday – but that was apparently caused by a trading error). Amid the headlines, and the increased market volatility, we thought it might be helpful to take a look at how the sovereign debt situation has evolved and why it is causing so much noise (and by extension, investor anxiety).

Each day, there seems to be a new take on the story and many of the headlines have been conflicting. For example, consider the following:

• Two EU Ministers: No Bailout for Greece – Wall Street Journal (Jan 18)
• Merkel Says Greece Doesn’t Need Financial Support – Dow Jones (Mar 22)
• Fears rise that Greece is days from defaulting – Associated Press (Apr 12)
• Greece begins talks on details of IMF aid deal – Reuters (Apr 22)
• EU: Greece loan package coming soon but worries persist – Globe (Apr 30)
• Greece swallows tough medicine in bailout – Globe (May 3)
• Analysts like Greek bank despite nation’s woes – Bloomberg (May 4)

However, as is often the case when it comes to complex issues, there’s usually more to the story than meets the eye. The situation in Europe is complicated and very volatile and many investment management teams are monitoring new developments closely.

Also, amid the noise, it should be noted that there have been other developments that, while not front page news, are noteworthy nonetheless from an investment standpoint.

For example, the U.S. dollar has strengthened which has benefited U.S. dollar denominated investments, and global bond spreads have widened, creating potential investment opportunities.

Another important note is that many of our favorite dividend growth stocks have returned to profitability. Regardless of the happenings in the world economy, when our dividend growth stocks are making money, we will be rewarded accordingly… But, it will take faith in our philosophy and time for the markets to catch up to us .

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 However, long-term Investors who choose to sit in perceived ‘safe’ investment like savings accounts, CDs and money market funds should realize that the historically low yields are likely going to leave their portfolio returns flat for some time.

In response to the low yield environment, it seems that some are taking innovative (albeit somewhat questionable) measures. That said, an interesting investmetn vehicle has popped up in France that gives a whole new meaning to ‘alternative investing’. It seems that investors over there are turning their attention to an age old option – cow lease contracts!

Cow Lease Contracts

The process goes something like this:

Buy a couple of cows and rent them out to professional farmers for milk production. From a cost perspective, this is a plus as it helps the farmers generate cash flow and frees up money for other necessary expenditures like buildings and machinery. This type of meat market may sound extreme but promoters of cow leasing suggest that the potential yields are 4 to 5 times that being paid on savings vehicles today.

As the herd grows, each new cow represents a new source of cash flow. New offspring cover deaths in the herd, some cows are sold off to cover maintenance costs and in particularly fertile years, the return on investment for each cow can be as high as 7%. Investors can sell the new cows for cash or continue to build up their herd to then draw a regular income at retirement.

Cow Lease Risks

Although it may sound like a nifty little investment strategy, as with all investments these cash cows are not without risk. Fluctuations on the price of meat, milk and animal feed as well as unexpected disease are just some of the considerations for cow contract investors.

While environments of change often motivate innovation (did you know that Disney, FedEx, Microsoft and Apple were founded during periods of economic recession?), discipline remains the key to long-term investment success.

As dividend growth investors, we must remain confident that we are on the right track to achieving our long-term goals. Whether those ultimate investing goals are growth or income.  It also means that we won’t need to follow the herd on the latest investment fad or have to convert our houses into cattle ranches anytime soon!

The following are three high-level economic data points that we can use, along with our other tools, to further assist us determining our views on equity market investments.

1.) U.S. Housing

As the root of the credit crisis, healing in the U.S. housing market is a precondition for sustainable recovery. Recent data has confirmed that the worst is behind us and the residential real estate market is stabilizing.

The inventory of unsold houses while still high is heading in the right direction towards clearing and sales of existing homes have recently turned positive on a year-over-year basis. And an index which measures year-over-year price changes of houses in 20 major U.S. cities (the S&P/Case-Shiller Home Price Index) plunged 33.6% from its June 2006 peak to the April 2009 trough, but has now climbed 1.9% over the past two months.

2.) The U.S. Consumer

The resurgence of the U.S. consumer will be key to watch as recovery unfolds since consumption is 70% of the American economy. Despite the ‘hit’ that the housing crisis has exacted on their net worth, American household balance sheets are still in relatively better shape than they’ve been in the past due to the tremendous growth net worth over the last decade.

However, the process of deleveraging (winding down debt) has begun and this will impact spending patterns in the near-term.

3.) The U.S. Manufacturing

The level of manufacturing has historically followed an inverse path to the Fed funds rate but on a 6-month lagged basis – as the fed funds rate drops, six months later, manufacturing activity picks up.

However, in fall 2008, although rates declined to historically low rates, the credit crunch intensified and that typical relationship between low interest rates and increased manufacturing activity did not materialize. More recently, credit channels have opened up and the ISM (gauge of manufacturing activity) has improved, indicating the economy is finally responding to massive stimulus after a long lag.

And further improvement just yesterday with the latest ISM level better than expected at 52.9 – the first reading above 50 since January 2008 and hit the highest level since June 2007. This is further indication that while not yet normal, the economic environment is normalizing.

These are three key areas of the market to watch when assessing the high-level economic situation and it’s relationship to the stock market trends and valuations.

Of course this isn’t the be all and end all of data you should include in your due diligence, but it certainly plays a role as you calculate your risk tolerance moving forward.