April 20, 2008 in Business

Investing abroad losing its luster

USA Today The Spokesman-Review
 

U.S. investors have been sending their money abroad for the past several years. When that money has returned, investors have been able to boast about their “savoir faire” and “elan.”

This year, however, U.S. investors have been yelling, “Sacre bleu!” and “Zut!” What investors have forgotten is that investing outside the United States isn’t always a cure for U.S. stock market malaise.

The past five years, investors have put a net $372 billion into diversified international funds, according to Lipper, which tracks the funds. To put that in perspective, it’s more than two-and-a-half times the value of the gold in Fort Knox at today’s prices. For much of the past five years, investors have been amply rewarded for shipping money abroad. The Lipper International Fund index has soared 164 percent in the past five years, versus 70 percent for the Standard & Poor’s 500 stock index.

This year, however, the results have not been quite as happy. The S&P has fallen 6.5 percent this year, versus 5 percent for the Lipper International Fund index. What gives?

International funds need two things to clobber U.S. stock funds. The first, and more important factor, is good returns from abroad. And most countries’ stock markets have fared very well the past five years.

The German stock market, for example, has gained an average 16.5 percent a year since April 2003, according to MSCI Barra, which tracks foreign markets.

Currency is the second. The falling dollar has turbocharged foreign investments. When the dollar declines in value, international investments rise. Think of it this way: Suppose you bought 1,000 euros five years ago, and stuffed them in a safe-deposit box in the Banque de Blancmange. Back then, a euro was worth $1.09, so you’d have spent $1,090.

Today, however, a euro is worth $1.59. Were you to open your safe-deposit box and convert your euros to dollars, you’d have $1,590 – a 46 percent gain.

Combining hot stock markets with a tumbling dollar makes for very happy returns. For example, we’d mentioned earlier that the German stock market gained an average 16.5 percent a year. That’s measured in euros. When converted into U.S. dollars, the German market has soared 25.9 percent a year.

Clearly, then, the best time to buy an international fund is when overseas markets are booming, and the dollar is crawling into the cellar. And that pretty well describes the past five years.

Unfortunately, the next five years may not be quite as good. The European economy has been slowing, and S&P expects euro-zone earnings to slow, too. Lower earnings augurs lower stock prices. Thursday, Finnish cell phone maker Nokia offered gloomy earnings guidance; the stock fell more than 14 percent.

European stocks account for about half of all overseas funds’ portfolios, says Alec Young, international equity analyst at S&P. Should Europe falter, international funds will feel the pain.

What about the dollar? By one measure, the dollar is already undervalued. According to economic theory, common, identical items should cost about the same in different countries. Any difference in price between, say, England and the United States would be because one country’s currency is over- or undervalued.

To test the theory, The Economist magazine created the Big Mac Index, which measures the price of McDonald’s famous burger in various countries. A Big Mac in the euro zone cost $4.17, versus $3.41 here – and that was back in July, when the index was last updated. At today’s conversion rate, a Big Mac costing the same 3.02 euros it did in July would cost $4.87, suggesting that the dollar is undervalued.

On a more concrete basis, the dollar tends to rise and fall according to differences in international interest rates. Money flows to the country with the highest rates. Currently, the U.S. federal funds rate, the key overnight loan rate, is 2.25 percent. The European Central Bank’s equivalent rate is 4 percent. Not surprisingly, investors are selling dollar-denominated investments and heading to Europe.


Thoughts and opinions on this story? Click here to comment >>

Get stories like this in a free daily email