Foreign Equity Funds and ETFs -- First Quarter 2005 Review

Foreign Stock Markets Offered Little Solace

April 4, 2005 -- Apparently, there was nowhere to hide.

International equity markets provided little relief for investors seeking escape from negative returns in the U.S. Aside from a few isolated bright spots, like South Korea, Eastern Europe and Argentina, international stocks delivered negative to tepid returns in the first quarter of 2005.

However, Jeff Knight, Managing Director and Chief Investment Officer at Putnam Global Asset Allocation, notes that "almost all foreign markets actually gained ground in the first quarter even as the U.S. market fell. If we look at local market returns, i.e. before converting to dollars, only a few foreign markets fell in the first quarter."

The average international stock mutual fund edged up just 0.26% for the quarter, while the average global equity portfolio, which can also invest in U.S. stocks, slipped 1.25% on average. But that's still better than U.S. stock performance: The S&P 500-Stock Index declined 2.3% for the three-month period, while the NASDAQ composite plunged 8.1%.

Relative to the U.S., foreign stock markets are benefiting from higher profit growth, low local interest rates, a continued weak dollar, the growing U.S. trade deficit, and the perception that, despite a few years of outperformance, overseas markets remain undervalued and, particularly in the emerging countries, sport faster-growing economies.

"We are now in the midst of a global economic rebalancing process," said Knight. "Between 1995 and 2002, 95% of the world's GDP growth came from the U.S., and only 5% from the rest of the world. That was an unsustainable situation. Now, the growth rate outside the U.S. is picking up significantly."

Knight indicated that outperformance in foreign markets is now being driven more by improving fundamentals, rather than the effects of currency. "For the last three calendar years, the MSCI EAFE Index beat the S&P 500 every year," he noted. "However, 2004 represented the first year that foreign market returns were supported by strong fundamentals, instead of the currency translation effects of the weak U.S. dollar. Overall, in overseas markets, fundamentals continue to improve and valuation remains attractive; at this point, currency is a tail-end benefit."

In addition, U.S. investors are becoming more enamored of putting their money overseas. For example, the Investment Company Institute reported that of the $22.43 billion of inflows recorded by stock funds in February, foreign equity funds received more than half of that amount, about $11.95 billion.

One of the major themes overhanging global stocks markets is the price of crude oil, which just reached a record level in excess of $57 per barrel. High oil prices are a boon to oil producers such as Mexico and Russia, but a threat to highly-developed oil importers like Japan and Western Europe. With Goldman Sachs recently speculating that oil prices could undergo a "super spike" and soar as high as $105 per barrel, this is something that will eventually impact all nations' economies and stock markets. For the moment, however, high energy/commodity prices combined with robust global demand, should translate into continued good returns for emerging markets stocks.

Knight believes that, despite a relatively moderate first quarter, the emerging markets should outperform again this year, particularly as more money flows into these economies. "We are still in the early days of high capital inflow and outperformance in the emerging world," he said.

Another aspect of "global economic rebalancing" that is reshaping world economies, Knight contends, is the rising prominence of China. "The character of the growth of the development of foreign economies is very much defined by the industrialization and infrastructure development of China," he said. "This is a resource-intensive development, as China will continue to have a huge demand for materials and commodities. More countries will increase their imports to China, and become less dependent on selling their products to the U.S."

Knight also expects Western European stocks to outperform U.S. markets this year, due to both the strength of the euro and economic fundamentals. Aside from Germany, Europe is fairly strong, he noted. "Corporate profits are pretty good, buoyed by the increased practice of outsourcing to countries with cheaper labor costs." However, further strength to the euro could eventually hurt the profitability of large-cap European exporting companies, and negatively impact their stock prices, he added.

Given that some of the first quarter's worst-performing funds invest in Japan, Knight noted that although the recession there may be over, the country is still not out of the woods. He cited such factors as deflation, lack of demand, demographics, high oil prices, and competition from new markets, among others, as reasons to remain cautious about Japan.

In order to maintain portfolio diversification and control risk, Knight thinks the average investor should currently increase his allocation to foreign equities. His portfolios are currently overweight in the emerging markets, resources-based economies, like Australia, and energy companies.

Standard & Poor's Investment Policy Committee presently recommends a 20% allocation in foreign equities as part of an investor's overall diversified portfolio.

International Equity Funds & Exchange-Traded Funds
Best Performers

First Quarter 2005 Returns (%)

Worst Performers

First Quarter 2005 Returns (%)

iShares MSCI South Korea Index Fund (EWY)

+10.9

Rydex Series Trust Large Cap Japan Fund/C (RYCJX)

-8.0

T Rowe Price Emerging Europe & Mediterranean (TREMX)

+10.8

Hartford International Capital Appreciation/B (HNCBX)

-8.0

Third Millennium Russia Fund (TMRFX)

+10.4

Seligman International Growth/B (SHBIX)

-7.9

AIM European Small Company Fund/A (ESMAX)

+10.2

iShares MSCI So Africa Index (EZA)

-7.5

Fidelity Advisor Korea/A (FAKAX)

+9.9

PIMCO: Japanese Stock+Total Return Strategy/Ist (PJSIX)

-5.6

Global Equity Funds
Best Performers

First Quarter 2005 Returns (%)

Worst Performers

First Quarter 2005 Returns (%)

Analytic Global Long-Short Fund (ANGLX)

+7.3

Seligman Global Growth/D (SHODX)

-9.9

Pearl Total Return Fund (PFTRX)

+6.6

Hartford Global Leaders Fund/B (HGLBX)

-9.6

Laudus Rosenberg Global Long/Short Equity/Ist (MSMNX)

+4.2

McIntyre Global Equity Fund (DGLEX)

-7.9

Tweedy Browne Global Value Fund (TBGVX)

+3.8

Oppenheimer Global Opportunities/C (OGICX)

-7.7

AIM Global Value Fund/A (AWSAX)

+3.6

Eaton Vance Global Growth/C (ECIAX)

-5.2

Source: Standard & Poor's. Total returns are in U.S. dollars and include reinvested dividends. Preliminary data as of 3/31/05.

Contact Bob Keane with questions or comments at: bkeane@investmentadvisor.com.

Reprints Discuss this story
This is where the comments go.