Gains Dim in Foreign Markets

By Tom Petruno

May 24, 2005 12 AM PT

Times Staff Writer

Time to come home?

Americans have been big buyers of foreign stocks over the last few years, as the weak dollar helped to pump up the gains generated by overseas markets.

But this year, the foreign affair has gone flat for many U.S. investors. The average foreign stock mutual fund was down 2.2% year to date at the end of last week -- matching the decline in the average U.S. equity fund, according to data firm Morningstar Inc.

In the next six months or so, economic and political concerns may raise the risks in foreign stocks, particularly in Europe, some analysts say. The U.S. market might look increasingly more appealing by comparison.

So far in 2005, the dollar’s about-face is the main problem for American investors in foreign securities: As the buck has rebounded in value against the euro, the yen and other major currencies since December, it has cut sharply into returns for U.S. investors.

For example, Germany’s blue-chip DAX stock index is up 3.5% this year measured in euros. But because of the euro’s slide, the DAX’s return is a negative 4% when translated into dollars, according to Bloomberg News data.

That compares with a 1.5% decline in the U.S. Standard & Poor’s 500 stock index this year.

By contrast, in 2004 the DAX index rose a modest 7.3% in euro terms but jumped 15.5% in dollars, as the euro appreciated against the greenback.

The dollar’s recovery has surprised many on Wall Street, and at a minimum it has squelched expectations that the U.S. currency was headed for another deep decline that would automatically fuel gains for Americans in overseas markets.

“It makes one wonder when U.S. investors are going to realize that the dollar is probably in for a choppy ride ... and that domestic equity investments may now be the better investment vehicle,” said Andrew Clark, senior research analyst at mutual fund tracker Lipper Inc. in Denver.

In April, Americans still were enamored of foreign stocks: Of the $13.5 billion in net new cash that U.S. investors were estimated to have funneled into stock funds last month, $11.3 billion went into foreign funds, according to Lipper.

To be sure, few investment advisors would recommend abandoning foreign stocks. They are considered to be an important element in a diversified portfolio over the long run.

And the dollar is continuing to fall against some currencies this year, lifting U.S. investors’ returns in stocks denominated in those currencies. The dollar’s weakness against Brazil’s currency has translated into a 1.2% gain for the main Brazilian stock index in dollar terms, even though the index has fallen 7.6% in its own currency.

Kurt Brouwer, a principal at financial advisor Brouwer & Janachowski in Tiburon, Calif., said the danger was that some investors were making large portfolio shifts into foreign stocks based solely on their performance in the last few years.

“Very often people are late to the party,” he said. “This is not the time I would make a big macro shift to international.”

If the dollar strengthens further, or just stays flat, the easy money in foreign securities has already been made with the handsome returns of 2002-2004, many experts say. Through last week, the typical foreign stock mutual fund earned an average annualized return of 9.3% over the last three years, compared with 5.2% for the typical U.S. stock fund, according to Morningstar.

European stocks are a particular concern to some analysts. Western European markets have risen between 3% and 8% in euro currency terms since Jan. 1, a strong performance compared with most markets.

But Carl Weinberg, economist at High Frequency Economics in Valhalla, N.Y., said there had been a “disconnect” between the gains in European stocks and the trend in the Continent’s economy.

Growth in the region has been well below expectations, raising questions about the outlook for the rest of the year and 2006. But even amid the weak growth, European firms have had their earnings boosted by wage concessions granted last year by major labor unions, Weinberg said.

The concessions, however, were “a one-time windfall,” he said. “It’s hard to imagine how they’re going to get the same thing this year.”

Weinberg believes that many European investors may be poised to shift money from stocks to bonds, to lock in yields before they fall further. Bonds have already attracted significant sums this year, driving prices up and yields down: The yield on 10-year German government bonds fell to a generational low of 3.30% last week, down from 3.68% at year’s end.

European stocks also could be riled by this weekend’s referendum in France on the European constitution. A defeat could boost concerns about the long-term prospects for further integrating the region’s economy and making it more efficient.

Compared with Europe, some investment advisors say Asia’s emerging markets still are attractive.

Milton Ezrati, senior economist and strategist at investment manager Lord, Abbett & Co. in Jersey City, N.J., said his firm was “lukewarm” on Europe at best, but “we’re buying in South Korea and Taiwan because they’re cheap compared with the U.S. market.”

But Asia’s growth, which two decades ago depended on Japan, now largely depends on China’s continuing boom, said Paul Matthews, head of Matthews International Capital Management in San Francisco. The long-term challenge for many countries in the region is to “generate more growth internally than in their export sectors,” he said.

Matthews said investors should temper their expectations for Asian stocks, considering “that these markets have done pretty well for the last five years.”

Some analysts say that, even if foreign stocks’ near-term prospects dim, it’s more likely that many U.S. investors still have too little invested overseas than too much -- an argument for staying put in that sector. Financial advisors often recommend that 15% to 20% of an individual’s stock holdings should be in foreign shares.

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Out of last place

U.S. stocks, the poorest performers among major markets last year, are out of the cellar this year.

*--* Price change in dollars* Country/index YTD 2004 S. Korea (KOSPI) +9.4% +26.2% Mexico (IPC) +2.6 +48.0 Brazil (Bovespa) +1.2 +28.3 France (CAC) -0.1 +15.6 Britain (FTSE) -1.0 +15.5 U.S. (S&P; 500) -1.5 +9.0 Canada (S&P;/TSX) -2.4 +21.4 Hong Kong (Hang Seng) -3.9 +11.1 Germany (DAX) -4.0 +15.5 Japan (Nikkei) -7.6 +12.7

*--*

* Returns to U.S. investors, adjusted for currency shifts.

Closing the performance gap

The average foreign stock mutual fund was down 2.2% year to date as of Friday, the same as the average U.S. fund. That’s a big change from the last three years, when foreign funds far outpaced U.S. funds.

Year-to-date average total return by stock fund category

Latin America: +3.9

Emerging markets (diversified): +1.0

Europe: -1.1

All U.S. domestic: -2.2

All foreign: -2.2

Asia/Pacific (diversified): -3.2

Japan: -6.0

3-year average annual return by stock fund category

Latin America: +21.1%

Emerging markets (diversified): +17.0%

Europe: +11.0%