1995-96: REVIEW AND OUTLOOK : There’s a World of Optimism Surrounding Foreign Stocks

It’s hard to find a global money manager who doesn’t believe that foreign stock markets will beat U.S. stocks in 1996.

For individual investors, there are two ways to view that near-universal opinion: Either the majority will be proved wrong (as often happens), or the expected rush of American money into foreign markets will be self-fulfilling. Given the small size of most foreign markets, don’t be too quick to discount the latter, experts say.

Most foreign markets badly lagged American stocks in 1995, as blue-chip U.S. shares posted their best gains in 20 years. The Standard & Poor’s 500 stock index, up 34.1% for the year, beat most major foreign market indexes and most minor ones.

Measured in local currency Hong Kong came closest to U.S. returns, with the Hang Seng index up 23%. Britain also scored well: The FTSE-100 index rose 20%. Sweden and Switzerland were up similarly.

But dismal returns were more the norm for foreign investors. Japan’s blue-chip Nikkei-225 index eked out a paltry 0.7% rise in yen terms, as its rally late in the year barely recovered the decline earlier in the year. Germany’s DAX index gained just 7%, despite lower interest rates.

And in Pakistan, India and Taiwan, stocks plummeted 20% or more, victims of economic or political concerns, or both.

All in all, foreign stocks’ misery translated into an average gain of 9.7% for Americans invested in international mutual funds, versus 31.5% for the average general U.S. fund, according to fund-tracker Lipper Analytical Services.

And the 9.7% foreign return would have been less had the dollar not fallen against key European currencies. A weaker buck means foreign stocks are automatically worth more when translated into dollars.

So why so much optimism about foreign stocks in 1996? International mutual fund managers concede they’re betting in part on simple catch-up: The last good year for most foreign markets was 1993, when “emerging” markets (Mexico, Thailand, Malaysia, etc.) were the rage with American investors and foreign stocks in general far outpaced U.S. shares.

That situation totally reversed in 1994, as many emerging markets crashed and most European markets also performed poorly--and much worse than Wall Street--as U.S. and foreign interest rates rose.

Now, after two years of lousy foreign stock returns, there is a “major valuation differential between companies inside the United States and those outside,” says David Herro, manager of the Oakmark International stock fund in Chicago. “I’m finding foreign companies selling for tremendous discounts relative to their U.S. counterparts.”

One example, Herro says: Swedish car maker Volvo, whose shares are priced at just 2 times operating profits per share, while General Motors’ price-to-earnings ratio is about 7, he says.

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But low stock prices don’t necessarily mean attractive stock prices, unless the outlook for the local market and economy is improving. The big difference between 1995 and 1996 is that investors appear to have more reasons to be confident in the fundamentals that support foreign stock prices.

Falling U.S. interest rates, for example, are helping to drive rates lower in many foreign countries as well. In addition, decelerating corporate earnings growth in America should make many foreign companies’ still-healthy growth rates appear more attractive.

Region by region, here’s how some international stock fund managers see the year shaping up:

* Japan: This is the big 1996 bet for many U.S.-based managers. There is a rising sense that Japan’s central government and central bank have finally come to grips with the severity of the country’s economic woes and are moving quickly to put the economy--and markets--back on growth paths.

“I’ve been a bear on Japan for seven years, but now it’s my first preference” among markets, says Bill Wilby, manager of the Oppenheimer Global fund in New York.

Michael Gerding, manager of Founders Worldwide Growth fund in Denver, says he’s “finding more [Japanese] companies whose earnings are growing again.”

Although many investment pros concede that Japanese shares don’t look cheap, the perception of a turnaround in the market--after a six-year bear market--may be all that is needed to continue driving prices sharply higher.

* Asia outside Japan: “The 21st century is going to be the century of China,” declares New York investment manager Jim Rogers. But you wouldn’t know it from Chinese stocks, which have been trading near record lows recently.

Indeed, across Asia markets were held back in 1995 by tighter monetary policies (an effort to cool inflation) and political jitters (some of them China-inspired), despite the region’s famously high economic growth rates.

But in 1996 Asian central banks should begin to ease interest rates to match the moves in U.S., European and Japanese rates, and that should be bullish for Asian stocks, brokerage Salomon Bros. argues.

* Latin America: Oakmark’s Herro is still suspicious about Mexico’s economy and market after 1995’s crash, and he’s not alone. But U.S. fund managers generally expect continued turnarounds in other battered Latin markets, including Brazil and Argentina.

Wilby is particularly enamored of Argentina, which he says “has done everything right” with economic and monetary policies despite high social costs.

* Europe: The Old World is the big question for ’96. U.S. fund managers fear that France’s civil strife over the government’s attempts to shrink the welfare state is a sign that, in Gerding’s words, Europe “just doesn’t get it”--meaning most companies and governments won’t restructure fast enough to meet the competitive challenge from America and Asia.

Still, Gerding notes, Europe is a big place, “and there are some great companies,” such as Dutch electronics giant Philips.

Michael Howell, stock strategist at ING Barings in London, says East European and Russian stocks could be the big winners of ’96 as more U.S. investors hunt overseas. Just as in 1993, Howell says, it won’t take much of an inflow of fresh cash into emerging markets to make their performance suddenly sing again.