Foreign Equity Funds and ETFs -- First Quarter 2005 Review

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.

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: [email protected].