Why you need global stocks now

By Tim Middleton

U.S. investors dumped foreign stocks in droves last year, and for good reason: The dollar rose, and global economies fell.

A rallying U.S. dollar meant many foreign companies earned smaller returns because their local currencies were worth less. Even economies that had been outpacing the U.S. for years weren't immune.

That's a big reason overseas stocks have suffered more in this bear market. The average foreign-stock mutual fund in the Morningstar database crumpled 44.9% in 2008, compared with the 38.5% decline of the Standard & Poor's 500 Index ($INX).

But while some foreign currencies are still weak, the dollar's ascent has paused. PowerShares DB US Dollar Index Bullish (UUP, news, msgs), an exchange-traded fund that advanced 9.9% in the 12 months ending Jan. 21, was ahead only 0.2% in the past three months.

And that could again make overseas stocks one of the most attractive areas for investors in 2009. The global growth story paused, but the world isn't going away.

"Now, just as some investors are bailing out, it might be a good time to revisit" international equities, says Alan B. Lancz, a financial adviser in Toledo, Ohio. "There are definitely still pockets of problems and danger, but on the other hand, for the first time in a year and a half, with valuations down so much, we're seeing selective opportunities."

Too late to flee

Mind you, no stock investors in the world are making money in 2009: Every category of equity fund is down while bond funds, and especially municipal bond funds, are soaring. But the strength of bonds is a harbinger of better times for stocks.

The strongest taxable domestic bond categories in January are bank-loan and high-yield funds, up 4.1% and 3.6%, respectively, and they are both tied to the riskiest corporate borrowers. Long-term Treasury bond funds, the outstanding success story of 2008 because investors fled to their relative safety, are down 5.6% this month -- and that, too, is tied to a softer dollar.

Meanwhile, foreign policymakers have undertaken stimulus packages on a par with those being adopted in the United States, albeit somewhat more tardily. Combine that development with the dollar's slip, and any foreign-stock obituary looks premature.

On a percentage basis, investors cashed in twice as many shares of foreign-stock funds as domestic stock funds in 2008. But anyone still fleeing global stocks could be closing the barn door after the horse has bolted.

But where in the world?

Picking a market to invest in based on recent performance can be treacherous, though. The world's markets are noisy with volatility, and the sum can have a different direction than many of the parts.

As of the markets' Jan. 21 close, the only stock exchanges in the world showing positive returns this year were in Sri Lanka (14.4%) Shanghai (9.0%), Chile (4.0%), Brazil and Denmark (2.6% each), Venezuela (1.1%) and Norway (0.4%).

Overall, though, the world still seems to be underperforming the U.S. The MSCI EAFE Index, the broadest measure of foreign developed markets, was down 11.5%, and the MSCI Emerging Markets Index was off 9.2%, compared with the 7% decline of the S&P 500, the 6.2% loss of the Dow Jones Industrial Average ($INDU) and the 4.4% decline of the Nasdaq Composite Index ($COMPX).

It's all about the dollar

Moreover, crosscurrents can roil even markets dealing in the same basic stocks. Shanghai is ahead, but Hong Kong, just 764 miles south and representing the cream of Shanghai's stocks, is down 12.5%. The purest China play for U.S. investors, iShares FTSE/Xinhau China 25 ETF (FXI, news, msgs), is down 13.7%.

To a considerable extent, these results reflect the movements of the currencies in which the stocks are bought and sold. The yuan is up against the dollar; WisdomTree Dreyfus Chinese Yuan (CYB, news, msgs), an exchange-traded fund that tracks China's currency, was up 0.7% as of Jan. 21. That makes the Shanghai market stronger.

But U.S. investors can't buy Chinese stocks in the yuan; the Shanghai market is open only to domestic investors. U.S. investors buy them in U.S. dollars, to which the Hong Kong dollar is pegged. So a weaker dollar hurts the Hong Kong market.

Also, as of Jan. 21, the US Dollar Index Bullish ETF was up 4.9% this year, CurrencyShares Euro Trust (FXE, news, msgs) was down 6.7%, CurrencyShares Japanese Yen Trust (FXY, news, msgs) was up 1.2%, and CurrencyShares British Pound Sterling Trust (FXB, news, msgs) was behind 4.1%.

With the dollar so critical to foreign stocks, the big question is what happens to it next.

The dollar rally has paused, almost certainly because interest in U.S. Treasury bonds is waning due to their now-miserly yields. If this leads foreign investors to desert Treasurys, the dollar will fall harder -- especially in the face of federal deficits that will likely surpass 8% of gross domestic product within 18 months. Look for a fall; debtor nations do not have strong currencies.

Continued: The world won't go away

 1 | 2 | next >