Going Global
Adding an overseas fund could be just the tonic for your portfolio
When President Bush made the surprising decision to re-enlist Treasury Secretary John Snow in his cabinet, investors took that as a sign of the administration's "two dollar policy." In other words, Wall Street thinks the White House will talk about wanting a strong dollar but won't do much to keep the greenback from sliding further.
Many investors view this as a green light for continued traffic into foreign funds, since Americans who invest abroad can make money even if foreign stocks don't appreciate--so long as the dollar loses value.
The good news is that investors have been rewarded with outsize gains in foreign markets even without the benefit of the currency trade. British stocks were up 19.8 percent in 2004, but even in their local currency, U.K. shares rose 12.3 percent. Without the aid of the weak dollar, Spain's stock market still surged 22.9 percent, Italian shares soared 24.8 percent, and French stocks were up 14.2 percent. Overall, international stock funds gained nearly 18 percent last year, according to the fund tracker Morningstar. By comparison, the average domestic stock fund posted a gain of only 12 percent.
Gold rush. Not surprisingly, money has rushed into foreign shares. In a record-breaking year, international or global portfolios attracted an estimated $100 billion in new investments, according to Strategic Insight. That's up from just $41 billion in 2003.
Nevertheless, market watchers say it's dangerous to invest overseas simply because you think the dollar will continue to fall. To be sure, many economists do think the dollar will slide further this year, in the face of a growing federal budget deficit and still-low interest rates. Standard & Poor's predicts the greenback could lose an additional 10 percent of its value this year. But given that the dollar has already weakened for three years, "it's getting late to play the currency game," warns Stuart Schweitzer, global investment strategist for J.P. Morgan Fleming Asset Management.
Investors should instead focus on the fundamentals, Schweitzer says. The primary argument for going abroad in the short term is that foreign stocks are trading at cheaper valuations than U.S. shares, despite outperforming domestic stocks in recent years.
Ben Inker, director of asset allocation strategy for the investment management firm GMO, notes that foreign stocks (minus Japan) are sporting a price/earnings ratio of 15.5 based on trailing 12-month earnings. Meanwhile, they are yielding around 3 percent in dividends. By comparison, the S&P 500 index of U.S. blue-chip stocks has a P/E of almost 21, says Inker, with a meager dividend yield of 1.7 percent. He adds that emerging markets are even cheaper than those of developed foreign economies, with a P/E of only 12.
While Europe's stock markets have outperformed the United States' recently, earnings in the Eurozone are expected to slow this year as the stronger euro cuts into exports--and profits--of European-based multinational firms trying to sell to the United States. The gross domestic product in the Eurozone, for example, is expected to grow only 1.7 percent this year. Last year, European GDP growth was forecast at 2.2 percent for 2005.
In the money. No wonder that 22 percent of global fund managers surveyed recently by Merrill Lynch favor the emerging markets as the best investment for 2005. That's compared with the 19 percent who think European stocks will shine and the 14 percent who think U.S. equities will lead the global markets.
Many analysts think companies in Asia and Latin America will shine. Many of the Asian Tigers such as South Korea are likely to continue to benefit from the breakneck pace of the Chinese economy.
Many Latin American and Asian companies are also poised to thrive from the global economy, especially those that produce the basic raw materials, ranging from steel to copper to building materials, that the industrialized world requires to keep going. These are companies like Mexico's Cemex, a cement and building material supplier, and Daelim Industrial, a South Korean engineering and petrochemical company. "As long as short-term interest rates are below the rate of inflation--which they are still--commodities tend to do well," says Jack Ablin, chief investment officer for Harris Private Bank.
Investors eyeing the emerging markets should probably stick with a diversified fund. These include funds such as T. Rowe Price Emerging Markets Stock, Vanguard Emerging Markets Stock Index fund, or Excelsior Emerging Markets. Another way to play emerging markets, says Susan Byrne, chief executive of Westwood Management, is to invest in large U.S. companies that benefit from the development of those emerging economies. These would be blue-chip companies like Caterpillar or 3M.
Still another option is to consider which sectors of the U.S. economy tend to rely most on foreign revenues. Sam Stovall, chief investment strategist for S&P, did just that. Based on 2003 figures, he determined that 53 percent of the revenues of tech companies in the S&P 500 are generated overseas. In addition, about a third of sales in the industrials and basic materials sectors are foreign. "You have to look at what you've already got," says Christine Benz, associate director of fund analysis at Morningstar.
Benz notes that in addition to indirect foreign exposure, many U.S. stock funds are directly investing in foreign shares. Though it's a U.S. fund, Fidelity Contrafund invests 17.5 percent of its assets in foreign shares. Fidelity Low-Priced Stock fund recently held 22.3 percent of its money overseas.
The bottom line: Investors should consider having a portion of their portfolios exposed to non-U.S. economies. But while the further weakening of the U.S. dollar is likely to be the icing on the foreign investing cake, investors should focus on the cake.
This story appears in the January 17, 2005 print edition of U.S. News & World Report.