Some Caution After World-Class Performance
Nothing succeeds like success, particularly when it comes to foreign stock markets and the appeal they hold for American investors these days.
When the mutual fund industry’s trade group reports on January purchases of stock funds this week, the numbers are almost certain to show further massive cash inflows to foreign portfolios.
That would be a continuation of the trend in 2005, when U.S. investors bought a net $105 billion of foreign fund shares, a record. That was more than three times their purchases of domestic stock funds last year.
The dollars pouring into foreign shares this year, combined with aggressive buying by local investors in many of those markets, have produced returns well in excess of what U.S. stocks have mustered.
That, in turn, is attracting even more money, because investors almost universally love what’s already doing well.
It helps that the dollar has weakened this year against many other currencies. That boosts the value of foreign stocks denominated in stronger currencies.
Yet cracks are appearing in the foreign-stock juggernaut.
In Japan, one of last year’s hottest markets, there are growing jitters about rising interest rates.
Among smaller markets, a sudden swoon in Iceland’s currency last week tripped shares there and dredged up memories of the late-1990s’ Asian currency crisis, which devastated that region’s stocks for a time.
On Friday, Philippine shares slumped after the government declared a state of emergency, citing an alleged coup plot against President Gloria Macapagal Arroyo.
On Wall Street, some pros are telling clients to be wary of chasing foreign markets in the near term, even though the long-term story remains compelling.
Brokerage Morgan Stanley on Feb. 6 advised investors to reduce their bets on Japan and emerging markets in favor of what the firm said were undervalued U.S. shares.
But a few numbers show why it’s difficult for Americans to tear themselves away from the foreign story. Who wants to leave a good party?
In India, the Bombay Stock Exchange 500 index is up 7.6% year to date after rocketing 37% last year. Brazil’s main market index has surged nearly 15% this year after a 28% jump in 2005.
By contrast, the U.S. Standard & Poor’s 500 index is up about 3% since Jan. 1. That was its gain for all of last year as well.
The bulls are running hardest in some of the world’s less-recognized bourses, whose stocks aren’t likely to be found in most of the foreign mutual funds available to American investors.
Saudi Arabia’s main market gauge, the Tadawul all-share index, hit a record high last week and is up 23% this year. That is on top of last year’s 104% advance. In fact, the Saudi market hasn’t had a losing year since 1998.
Neither has the unheralded Romanian market had a down year since ’98. It has tacked on a 21% advance year to date.
Certainly, there are fundamental underpinnings for the robust gains in many foreign markets. Saudi Arabia’s economy, not surprisingly, is booming thanks to the wealth that high oil prices have generated for the kingdom.
Brazil’s trade surpluses have lifted its economy, and the government is paying down foreign-owned debt and lobbying credit-rating firms for an upgrade in the country’s bond rating, which is on the cusp of the coveted investment-grade mark.
In Japan, share prices have been powered by rising corporate earnings and the belief that the economy can sustain its recovery and close the door on more than a decade of misery.
What’s more, referring to classic valuation yardsticks such as price-to-earnings ratios, many analysts believe that foreign stocks overall aren’t overpriced, even if they aren’t the screaming bargains they were a few years ago.
In its Feb. 6 report, Morgan Stanley said emerging markets “do not look materially overvalued.” Nonetheless, the firm added, the continuing run-up in many markets has left much less room for error.
Japan is one place where investors seem to be genuinely worried that stocks have risen too far, too fast.
The Nikkei-225 share index has stalled out and is flat year to date after soaring 40% in 2005. The market has been hurt in part by rising yields on Japanese bonds, as investors bet that the economy’s rebound will spur the Bank of Japan to lift interest rates from rock-bottom levels this year.
On Friday, the yield on five-year Japanese government bonds hit 1.11%, up from 0.86% at year’s end and the highest level since 2000.
In tiny Iceland, where the main stock index has zoomed 417% since the end of 2001 (compared with a mere 12% gain for the S&P; 500 in the same period), financial markets got a scare last week after U.S. credit rating firm Fitch issued a warning about “all the signs of economic overheating -- rising inflation, rapid credit growth, buoyant asset prices, a steep current account deficit and escalating external indebtedness.”
Who knew Icelanders had a debt problem? In any case, Fitch’s warning triggered a sudden plunge in Iceland’s currency and stock market on Tuesday.
The selling spilled into some other smaller markets worldwide amid fears that Iceland, like Thailand in 1997, might be signaling a broader retreat by global investors from overvalued currencies and securities.
The Thai currency’s collapse was the start of a meltdown across Asia as foreign money fled. Thailand’s stock market plunged 55% in 1997, while the South Korean market dived 42% and Singapore’s stocks slid 24%.
By the end of last week, however, Iceland’s market storm had blown over. Its share index lost a modest 1.4% for the week and still is up 20% year to date.
And there was little net damage to other emerging markets. In the Philippines, the coup threat clipped as much as 2% from share prices on Friday, but the market recovered half of that loss by the close as buyers jumped back in.
A thwarted terrorist attack on a huge Saudi oil facility on Friday seemed to be mostly ignored by world stock markets.
Investors’ broad enthusiasm for emerging market stocks, in particular, reveals a sea change in how those economies are perceived, and why they now must be considered a vital element in a diversified portfolio.
The stunning rise of China, of course, has laid to rest any thought that the growth in many up-and-coming economies is a flash in the pan.
The Economist magazine, in a report in January, estimated that emerging economies’ combined output in 2005 accounted for more than half the global total. In other words, the developing world has overtaken the developed world in terms of share of gross global product.
Three other numbers in the report stood out: Emerging economies have five-sixths of the world’s population, hold two-thirds of the planet’s foreign exchange reserves, yet their stock markets account for just 14% of global capitalization.
All of this suggests there is much more potential for wealth generation in those markets in the long run. Likewise in Japan, where stocks still are playing catch-up after years of dismal results.
Europe may be more of a question mark, given its aging population and subpar economic growth. But you wouldn’t know that from the strength of most European stock markets this year.
The basic problem for investors who love the foreign story is that although the investment case for the next five to 10 years is solid, the next six to 12 months is worrisome.
The higher many foreign markets climb in the near term, the greater the risk that any sell-off could turn vicious in a hurry if enough investors with huge, built-up capital gains tried to cash some in. We know that markets don’t go straight up forever, even though there are times when it seems as if they will (anyone remember Nasdaq’s boom in 1999?).
At a minimum, Americans would be well-advised to proceed slowly with foreign investing now. There may be no reason to change a regular investment plan, such as in a 401(k) account. But only the bravest of gamblers would be thinking about shifting a huge chunk of their portfolios overseas all at once.
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Good times abroad
Most foreign stock markets outpaced U.S. blue chip shares in 2004 and 2005 and are doing so again this year. In most foreign markets, U.S. investors’ returns have been boosted this year by renewed weakness in the dollar, which makes foreign securities worth more to U.S. owners.
*--* Percentage change: (in local YTD change: currencies) Market/index 2004 2005 local in dollars Russia/RTS +8.3% +83.3% +30.2% +30.2% Brazil/Bovespa +17.8 +27.7 +15.4 +26.0 Turkey/ISE-100 +34.1 +59.3 +17.8 +20.4 Poland/WIG +27.9 +33.7 +11.8 +14.6 Iceland/main +52.9 +60.9 +19.6 +13.6 China/Shanghai compos -15.4 -8.3 +11.7 +12.1 Germany/DAX +7.3 +27.1 +8.6 +9.0 India/Bombay 500 +17.5 +36.6 +7.6 +9.0 Mexico/IPC +46.9 +37.8 +7.3 +8.6 France/CAC +7.4 +23.4 +7.6 +8.0 Canada/S&P-TSX; compos. +12.5 +21.9 +4.8 +6.1 Britain/FTSE-100 +7.5 +16.7 +4.3 +5.9 South +10.5 +54.0 -1.0 +3.5 Korea/compos. U.S./S&P; 500 +9.0 +3.0 +3.3 +3.3 Japan/Nikkei-225 +7.6 +40.2 -0.1 +0.9
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Source: Bloomberg News
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Tom Petruno can be reached at tom.petruno@latimes.com. For recent columns on the Web, visit: www.latimes.com/petruno.
