Foreign Stocks Again Test Patience of U.S. Investors
For U.S. investors, staying home has mostly been the best idea this year--a theme that became very familiar in the late 1990s.
With the year nearly half over, 2001 is shaping up as the sixth year in seven that Americans investing in foreign stocks have under-performed those who kept their money in U.S. stocks.
Despite a few hot spots overseas, including Mexico, Russia and China, most foreign markets are trailing U.S. markets after adjusting for currency translations.
“It’s amazing that the U.S. has held up better than foreign investing despite the meltdown on Nasdaq,” said David Bowers, global strategist at Merrill Lynch.
Through Wednesday, the average foreign stock mutual fund was down 10.5% year to date, according to Morningstar Inc.
By comparison, the average U.S. stock fund was down 3.4%.
Many foreign equity markets have been slammed by the global economic slowdown. Some analysts say Europe and Japan--where the bulk of foreign-fund assets are invested--may test investors’ patience at least through summer.
“It’s hard to be bullish internationally because there’s still a lot of denial about the depth of problems” in the economy, Bowers said. “The news flow and earnings may get worse before they get better.”
Though central banks in the United States, Europe and Japan have lowered interest rates this year, “the benefits of global monetary easing might not be felt overseas until next spring,” he said.
Yet for U.S. investors, the bigger problem in many markets has been the dollar’s strength. A rising dollar automatically depresses the value of foreign stocks for U.S. investors because weaker currencies translate into fewer dollars.
For example, measured in euros, the main German stock index is down 3.9% this year. But with the euro’s plunge, the German market is down 13.2% in dollar terms.
Many economists have been baffled by the dollar’s strength. If or when it weakens, however, it could have the opposite effect on U.S. investors’ foreign holdings: Those assets would automatically rise in value.
Some experts say there are fundamental reasons for optimism about foreign markets. Japan’s new government could generate true reform, for example, though it may be painful; and many fund managers insist they are finding plenty of stock bargains overseas, where valuations are often lower than in the U.S.
“There’s more disillusionment now about foreign investing and a lot of people are saying, ‘Why go overseas?’ ” conceded Morning-star analyst Bill Rocco. “But I still believe in the argument that you want global exposure.”
When foreign stock markets move, they can be explosive.
In 1999, for example, many foreign funds out-gained even U.S. blue-chip funds. Fidelity Diversified International surged 50.6% that year.
Even this year, some foreign funds are shining--mostly those that adhere to a “value” investing approach. Longleaf Partners International fund, for example, is up 14.7% this year.
Michael Welsh, co-manager of Oakmark International Small Cap and two other global funds--all in the black--said he is finding plenty of “cheap, high-quality stocks” abroad.
Here is how analysts and money managers see the major issues facing foreign markets, by region:
* Europe. European stock funds are down 13.4% this year in dollar terms, on average. Russian funds--a wild sector few Americans have gone near--have been an exception, with Pilgrim Russia up 49.5% and Third Millennium Russia up 46.8% as the natural resources sector has rallied.
Rocco points out that many diversified foreign funds “are really glorified Europe funds,” with 75% to 80% of assets in European stocks. Though some foreign-fund managers stay hedged against currency fluctuations, many don’t hedge--which means they bear the full hit of a strong dollar.
“There’s no question the dollar is overvalued almost everywhere and investors who own foreign assets would benefit when it weakens,” said John Bollinger, head of Manhattan Beach-based Bollinger Capital Management.
“The question is: What’s the event that comes along to reverse the psychology of an inevitably strong dollar? Even with our problems, the U.S. is still one of the strongest economies.”
* Japan. Japanese stock funds are down 3.6% in dollar terms, on average. They’ve been aided a bit as the yen has firmed on optimism for economic reform. But analysts say Japan needs to follow through with promises of reform--promises heard before.
“Japan should be on everyone’s watch list. But I’d want to see evidence that the country is coming to terms with its debt problem and really reforming its banking system,” Bollinger said. “We’re in a ‘show-me’ stage for most of the world’s economies, especially Japan.”
Welsh noted that “massive liquidity refuses to go into the Japanese stock market even with interest rates at zero. Investors have continually been hoodwinked and shellshocked, so psychology is a key issue.”
* Emerging markets. These funds have gained 1.1% this year, on average. Dreyfus Emerging Markets, one of Rocco’s favorites, is up 9.3%, boosted in part by a rally in Mexican stocks as interest rates there have plunged. Regional Latin American funds are up 4.9%.
“If you believe monetary easing is going to work and next spring there will be a turnaround in global economies, then emerging markets should be an attractive asset class,” Bowers said. “I just wouldn’t be making any bets for now.”
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A Rough Year for U.S. Investors Overseas
Stocks have mostly been a losing proposition worldwide this year, but the damage has been worse for U.S. investors in foreign markets because of the dollar’s strength. A strong dollar means losses in foreign markets are magnified. Here’s a look at the year-to-date price changes in key market indexes, expressed in native currencies and in U.S. dollars:
Source: Bloomberg News
