July 1, 2004 — Despite an economic recovery in the U.S. and reasonable corporate earnings growth in many countries, foreign stock markets have, on the whole, delivered uninspiring returns through the first half of the year. The average international equity fund returned 3.1% through the end of June, just below the 3.3% gain for the S&P 500. The average global equity fund, which invests in both U.S. and foreign stocks, also edged up 3.1% in the first half.
Global equities, to varying degrees, face pressure from lofty energy prices, higher interest rates in the U.S., the seemingly endless violence in Iraq, and fears of a second-half slowdown in the mammoth, commodity-hungry Chinese economy. While certain smaller countries such as Colombia, Austria, Hungary and Czech Republic have posted outsized gains, equity markets around the globe are generally sluggish amidst concern that the global rally will peter out.
To be sure, foreign stock investors may have breathed a sigh of relief when, as expected, the Federal Reserve hiked rates by 25 basis points and offered a “measured” pace of tightening. Indeed, global equity markets had already discounted the first rate increase.
Asia: Japan Surges, But Chinese Slowdown Casts Shadow
This year’s best performing international stock funds invest in Japan, one of the globe’s brightest markets. The Japan MSCI Index is up a healthy 10%. Aside from progress in structural reforms, strong GDP growth, and robust consumer spending, Japan’s recovery has been buoyed by its growing export business to China.
The five highest-returning foreign stock funds all invest in Japanese stocks, with the top three portfolios — DFA Invest Grp Japanese Small Company Port (DFJSX), Fidelity Japan Smaller Companies (FJSCX), and Japan Smaller Companies Fund (JSCFX) — benefitted from the surging small-cap sector in Japan. The Russell/Nomura Small Cap Value Index has soared 29.6% year-to-date.
Despite strong performance, two major risks cloud the economic picture: demand in China is expected to slow down appreciably; and Japan’s 100% dependence on expensive foreign oil could cut into corporate profits and hurt consumer confidence.
Lauretta Reeves, chief investment officer at Hansberger Global Investors, finds Japan a bit too rich these days. “On the basis of price-to-cash-flow and especially P/E, the Japanese market is more expensive than the international markets in aggregate,” she notes. “It is still difficult for us to find attractively valued stocks with which we are comfortable as many have muted growth prospects.”
South Korea, an increasingly important Asian economic power, but which is susceptible to high oil prices and U.S. interest rate movements, tumbled about 15% in the second quarter, finishing about flat for the first half.
After soaring to dizzying heights in 2003, India’s stock markets have plunged nearly 19% this year. Indeed, last year’s top performing foreign stock fund, the Eaton Vance Greater India Fund (ETGIX), now ranks as the sector’s worst performer, illustrating the extreme volatility of emerging markets investing.
Bombay’s SENSEX Index was thrown for a curve with the unexpected victory of the Congress Party in the recent national election. Viewed as less business-friendly than the former ruling BJP party, Congress’ July budget will give jittery investors a better idea of Indian’s future fiscal policies.