Tide has turned on foreign stocks
Foreign stocks had been the shining stars in many U.S. investors’ portfolios from 2003 through 2007. This year, they’re beginning to look like black holes.
With the global economic outlook fading and the dollar rebounding, Americans’ foreign holdings are suffering a double-whammy. If you haven’t checked your portfolio lately, you may be in for a shock.
The average foreign stock mutual fund has plunged 18.1% year to date, according to Morningstar Inc. That’s more than double the 8.6% decline of the average U.S. stock fund.
The heavy losses overseas pose another difficult test for weary investors already hurt by declines in other corners of their portfolios and by falling home prices.
In particular, this turnabout is a blow to Americans who were late to begin riding the foreign-investing wave.
In 2006 and 2007 combined, U.S. investors pumped a net $404 billion into foreign mutual funds, according to Financial Research Corp. That was more than three times the net $125 billion invested in U.S. stock funds in the period.
“People jump on the bandwagon and think these trends last forever, but they don’t,” said John Kleponis, senior portfolio manager at financial advisor Yosemite Capital Management in Tustin.
As usual in times like this, advisors are trying to keep their clients focused on the long-term -- and on the benefits, over time, of maintaining a diversified portfolio that includes foreign and domestic investments.
Underpinned by brisk economic growth overseas, foreign stock funds on average generated bigger gains than the typical U.S. stock fund every year since 2002, according to Morningstar.
The story was too compelling to ignore: China’s explosive growth was powering economies across Asia; Brazil and other commodity exporters were reaping rising prices for their raw materials; and in Europe, economies such as Spain were enjoying housing-centered booms.
What’s more, the sinking dollar added a windfall to U.S. investors’ foreign-stock returns. As the dollar dropped, securities denominated in rising foreign currencies were worth more when translated into dollars.
In the five years ended last Dec. 31, for example, Germany’s DAX stock index rose 179% as measured in euros. But measured in dollars the gain was 292%. That far outpaced the 67% rise in the U.S. Standard & Poor’s 500 index.
This year, however, it’s payback time: Most foreign markets have lost far more than the U.S. market. One big factor in that shift is investors’ sense that, just as the U.S. economy in 2007 led the world into the current malaise, it could lead the way out.
“The thinking is that we’re ahead of the rest of the world in the economic cycle,” said Jim Paulsen, chief investment strategist at Wells Capital Management in Minneapolis.
The Japanese, German, French and Italian economies all contracted modestly in the second quarter, while the U.S. economy expanded at a 1.9% annual rate, helped by federal tax rebates to consumers.
Even if U.S. growth falters again there are other forces working against foreign stock markets now. One is the plunge in commodity prices over the last six weeks, which is threatening growth in emerging-market nations that are big commodity producers.
Also, Russia’s invasion of neighboring Georgia has resurrected concerns about the geopolitical risks inherent in emerging markets.
All of this is luring money back to U.S. assets, which in turn has fueled a surge in the dollar in recent weeks.
And as the greenback rebounds it erodes the value of foreign investments held by U.S. investors -- the opposite effect that the falling dollar had from 2002 through 2007.
Since June 30, the German DAX index is up 0.4% in euros but down 6.3% in dollars.
If the dollar continues to rebound into 2009 it could dampen foreign-stock returns for U.S. investors even if overseas markets begin to recover.
Some financial advisors believe U.S. stocks deserve an extended period of better performance compared with many foreign markets because the domestic market has lagged for so long.
“I think the U.S. market is much more attractive than any other markets I can think of,” said Kurt Brouwer, chief executive of advisory firm Brouwer & Janachowski Inc. in Tiburon, Calif.
Still, he and other advisors say investors who have well-diversified portfolios should be willing to hold tight to their foreign holdings. Given long-term growth prospects for many foreign economies, it makes less sense than ever for Americans to be invested only at home.
Many advisors recommend that clients keep 15% to 30% of their equity portfolios in foreign stocks. Paul Merriman, principal at financial advisor Merriman Berkman Next in Seattle, says the key is for investors to decide on a comfortable portfolio percentage for foreign holdings and then stick with it.
That strategy would have meant paring back on foreign stocks in recent years as they soared, Merriman notes. Investors who did that would have taken profits all along -- and probably wouldn’t feel as nervous now as those who’ve allowed their foreign holdings to balloon, he said.
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