With acts of terrorism overseas becoming more common and swine flu morphing into a pandemic, Americans have become more reluctant to travel overseas. But should you be investing your money in foreign companies? As Americans, we tend to think of America as the center of the Universe and fail to realize America only represents 23% of the global economy. A full 77% of the financial ‘action’ is happening outside the United States. In a global recession of the nature we now find ourselves, emerging market stocks will tend to lead us out of the recession, followed by developed country foreign stocks, then U.S. stocks. We saw this in the recent run-up in the stock market that began March 9th. Since that time, emerging market stocks gained 76%; developed country international stocks gained 64%; and U.S. stocks gained 49%.
Taking a look back at the bear market of 2000-2002, a similar scenario occurred in 2003, the year that marked the end of the bear market. U.S. stocks rose 29%; developed company international stocks rose 38%; and emerging market stocks rose 42%. How likely is it that this trend will continue as we move from a global recession to a global recovery? I believe it is highly likely. Even with the unprecedented financial stimulus that has been, and will continue to be provided by our government, the U.S. economy will likely take years to fully recover. In other words, we will experience slow growth compared to foreign countries. Part of this will be due to increased regulation imposed by our government and part will be due to the hangover resulting from the massive amount of debt the government has created.
Investing in foreign stocks creates a separate set of risks compared to domestic stocks. Reduced political stability and market transparency are especially evident in emerging markets such as China, India, and Brazil. You also encounter currency risks. For example, if you invested in a European stock mutual fund that rises 10% and the U.S. Dollar rises 10% against the Euro, your gains in stock values will be negated by your loses in currency values. This creates a risk and an opportunity. The opportunity here and now is that the U.S. Dollar has risen against most foreign currencies during this economic downturn because global investors have rushed to buy our treasuries as a ‘safe haven’. As global economies recover, it is likely that the U.S. Dollar will fall compared to foreign currencies creating the potential for a double-opportunity for Americans who invest in foreign stocks. Foreign stock shares will rise faster than domestic stocks and you’ll get an additional boost from foreign currency exchange.
There are many ways to invest in foreign stocks including individual shares, mutual funds and exchange traded funds. Two excellent choices are exchange traded funds:
- EEM for emerging markets
- EFA for developed country international stocks
Stocks, having risen sharply since the March 9th lows, may ‘fall back’ and build a new base. Your best strategy is to dollar-cost-average over the next six to twelve months and plan on a minimum holding period of two years. Consult your financial advisor before implementing this advice.