Major Foreign Markets Feel Full Effect of Global Economic Woes

Investors who got really exotic in their foreign stock picking last year had a chance to reap some spectacular gains.

Zimbabwe, China, Sri Lanka and Kuwait were standout performers among global equity markets in 2001.

But those investors who stayed with mainstream foreign markets in Europe and Asia suffered losses that were generally worse than what they would have endured in the U.S. market.

That means 2001 was the fifth year in the last six that American investors, on average, were better off keeping their money at home than in foreign markets.

The average international stock mutual fund sank about 19% in 2001, according to preliminary data from fund tracker Morningstar Inc.

By contrast, the average domestic stock fund fell about 12% last year, Morningstar data show.

The main weights on foreign markets last year were the same as on the U.S. market: a continued decline of the once-hot technology sector and a plunge in corporate profits overall as the global economy skidded into recession.

But Americans investing overseas also had to contend with the downside of the robust dollar: The U.S. currency’s strength was a boon for anyone traveling abroad, but it deepened foreign market losses when those shares’ values were translated from weaker currencies into dollars.

Among principal markets, Japan was the worst performer in 2001, reflecting widespread belief that its economy is the sickest of all major economies.

The blue-chip Nikkei-225 index fell 23.5% in yen for the year, according to Bloomberg News data. That far exceeded the 13% drop in the U.S. blue-chip benchmark, the Standard & Poor’s 500. The Nikkei’s decline also was worse than the 21.1% drop in the Nasdaq composite index.

The yen’s plunge against the dollar left a U.S. investor holding a basket of Nikkei-225 stocks with a net loss of 33.5% for the year, Bloomberg News data show. It took 131.62 yen to buy one dollar as of Monday, versus 114.4 a year ago.

The yen’s drop against the dollar in 2001 was the biggest calendar-year decline since 1989, Bloomberg News calculated.

The euro currency also lost value against the dollar in 2001, but the euro’s slide was much more moderate. One euro was worth 89 U.S. cents at year-end, down from 94 cents at the end of 2000.

The Bloomberg European 500 index, measuring Europe’s 500 largest stocks by market capitalization (stock prices times the total number of shares outstanding) dropped about 15% last year, slightly worse than the U.S. S&P; 500. But in dollar terms the European 500 was off nearly 20%.

Among individual European markets, France, Italy and the Netherlands saw their key indexes lose more than 20% for the year in euro terms. The Spanish market held up better, as the IBEX-35 eased about 8%.

The British market’s blue-chip index, the FTSE-100, fell 16.2% for the year in pounds, and 18.3% in dollars.

Because many U.S.-based foreign-stock mutual funds are heavily invested in European and Japanese shares, the performance of those markets was the principal determinant of the funds’ performance for the year--and will be the key to how they fare in 2002.

Brokerage Morgan Stanley, in its 2002 outlook report to clients, says major European stocks are priced about on par with U.S. shares, at about 20 times estimated 2002 earnings per share.

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Anticipated Returns for European Markets

Morgan Stanley strategist Richard Davidson predicts that European markets overall will produce returns of 5% to 8% this year, assuming the European economy revives in tandem with the expected U.S. recovery. The brokerage recently boosted European holdings in its recommended global portfolio allocation while paring its stake in Japanese stocks.

For beleaguered Japan, the central question is whether the government of Prime Minister Junichiro Koizumi can push through policy reforms that ultimately could reinvigorate that economy, said Morgan Stanley strategist Robert Alan Feldman. Those reforms include forcing banks to write off more bad loans, and changing the tax structure to enhance the economy’s efficiency, Feldman said.

Merrill Lynch & Co. strategist Masatoshi Kikuchi says the outlook for Japan’s economy and market depends on “a strong economic rebound in the United States, a recovery in the information technology sector, and a regaining of investors’ confidence in restructuring by Japanese companies.”

The dollar, as always, remains the wild card: If it continues to rise in value against the yen and other currencies, any gains achieved in foreign markets will be lessened for U.S. investors in those markets. The flip side is that if the dollar weakens it would automatically add to any foreign-market gains.

One potentially positive sign from the Japanese market in 2001 was that smaller stocks held up much better than larger stocks--mirroring the split U.S. market. Japan’s Nikkei-OTC share index of mostly smaller stocks fell 8.4% in yen last year, about one-third the loss of the Nikkei-225.

On Wall Street, the S&P; small-cap stock index rose 5.7% last year.

Smaller stocks generally are considered riskier than bigger names, but that didn’t pan out in 2001. Likewise, many emerging markets overseas shined in 2001 even as bigger markets slumped.

In Asia, South Korea’s main share index soared 37.5% for the year, boosted in part by optimism that higher government spending, along with tax cuts, will spur the economy in 2002.

In Taiwan the main index gained 17.1% last year, powered by technology stocks as investors bet the companies will benefit from a turnaround in the global economy.

In Latin America, Argentina’s market crumbled in anticipation of the country’s debt default. But there was little collateral damage across the region. Indeed, Mexico’s main share index added 12.7% for the year, and was even stronger in dollar terms as the peso rose.

The hottest markets of 2001 were those where most investors generally fear to tread.

Zimbabwe’s main share index rocketed more than 157% for the year, despite mounting political violence in the African nation. But the market’s gain in part reflected an inflation rate running at about 100%, and interest rates above 70%.

China’s B-share indexes in Shanghai and Shenzhen were up more than 90% for the year. Those shares had been limited to foreign investors until last year, when domestic investors were allowed to buy them.

Russia’s market, long viewed as a casino by foreign investors, also produced an outsized gain of 91.4%.

All in all, the average emerging-markets stock mutual fund fell about 7% in 2001, preliminary Morningstar data found. That was a far better performance than in 2000, when the average emerging-markets fund tumbled 31%.

Some analysts argue that if investors are betting on an economic recovery this year, emerging markets still have the best potential--for those who are willing to accept the (usually) greater risk involved.