Portfolios With a Foreign Flavor
Globalization may have been a dirty word a few years ago, when it meant U.S. jobs being shipped overseas. But in 2005, the term took on a positive spin as Americans discovered the fruits of investing in the foreign equity markets.
While U.S. stocks squeezed out rather modest returns--Standard & Poor's 500 index rose less than 5 percent last year--foreign markets partied like it was 1999.
Latin American stock funds returned more than 50 percent in 2005 while the average Japanese and emerging markets stock fund soared more than 30 percent.
Not surprisingly, American investors poured a record $149 billion into foreign equity portfolios. Market strategists think the party will continue in 2006.
"We're still pretty positive on the non-U.S. markets,"says Ernie Ankrim, chief investment strategist for Russell Investment Group. He's not alone. A recent survey by Russell found that 54 percent of money managers are "bullish" on foreign stocks, which makes them among the top three asset categories next year. "International markets have been beating the stuffing out of the U.S. for several years,"says Jonathan Golub, U.S. equity strategist for JPMorgan Funds. People just didn't notice until last year.
The average global equity fund has surged 7.3 percent a year for the past five years while its domestic counterpart is up just 2 percent annually.
U.S. economic growth adjusted for inflation is expected to rise 2.6 percent this year. But in Japan, the economy is expected to expand 3 percent, while in Latin America growth could soar 4.2 percent. And in Asia, growth is expected to surge 7 percent.
Sale bin. Foreign markets, though, are selling at a discount. John Chisholm, cochief investment officer at Acadian Asset Management, notes that European and emerging markets stocks are trading at lower price-to-earnings ratios than U.S. equities.
The gains for U.S. investors last year came in spite of a big headwind: the surprising strengthening of the dollar in 2005. When the dollar strengthens, U.S. investors abroad lose out. That's because their foreign holdings become worth fewer dollars as the value of the greenback rises.
But this year, many expect the dollar to turn right around and start to weaken again. Jack Ablin, chief investment officer for Harris Private Bank, thinks the dollar could lose around 5 or 6 percent of its value in 2006. Why? Well, one of the biggest reasons the dollar strengthened last year was interest-rate trends. While the Federal Reserve Board raised short-term interest rates by 2 full percentage points to fight inflation, central banks in Europe and Japan sat tight for most of last year.
The Fed is expected to finish hiking rates in the first quarter of 2006. And foreign central banks are expected to gradually lift their rates. This could eventually even out global interest rates, thereby reducing interest in--and the value of--the greenback.
The upshot: The headwind of the strong dollar could become a tailwind for U.S. buyers of foreign stocks. And if that's the case, those stocks will become even more attractive.
This story appears in the January 16, 2006 print edition of U.S. News & World Report.
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