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Portfolio > Economy & Markets

The World Is Flat

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Returns of foreign stock funds eroded for U.S. investors as the dollar gained against foreign currencies in the first half of the year.

Even though most global equity markets made modest gains in local currencies year to date, many have declined in dollar terms. For example, markets in the euro zone gained about 7% in local currency, but saw around a 5% drop in dollar terms.

Indeed, after a three-year decline, the U.S. dollar, which seemed to have bottomed out at the end of 2004, become resurgent again. Through the first half of 2005, the dollar gained roughly 5% against the yen, and 10% versus the euro.

The dollar’s reversal has thrown a new wrinkle into foreign stock-picking as investors are already grappling with high oil prices, rising U.S. interest rates, and a possible slowdown in the global economy.

The average international stock fund gained just 0.57% for the first half of 2005, while the average global equity portfolio, which can also invest in U.S. stocks, edged down 0.19%. In the second quarter, international stock funds rose 0.25%, while global stock funds picked up 1.4%.

Latin America: Rich on Commodities

Funds investing in South America have delivered among the highest returns so far this year, reflecting strong performance in the two biggest Latin economies, namely Brazil and Mexico. High commodity demand from China has been a driver.

Matt Hudson, manager of the American Century Global Growth Fund (TWGGX), noted that when the commodity cycle peaks, it will hurt countries like Venezuela, Brazil and Mexico disproportionately. But this has yet to happen.

Despite robust returns in Latin America, investors should remember it is still an emerging market, and susceptible to high economic and political volatility. For example, Brazil’s government is in the midst of a political bribery scandal, which could conceivably slow down fiscal reforms, and turn off foreign investors. “This exemplifies one of the risks of emerging market investing,” Hudson said. “There is a reason why valuations there tend to remain low, because of the inherent volatility and political risks.”

To illustrate the point further, high crude prices have actually not helped oil producer Venezuela. The country’s equity markets have declined sharply amidst endless political turmoil. Oil-rich Mexico presents less of a risk since its steadily strengthening economy is more closely tied to the U.S. . In addition, the peso has actually appreciated against the U.S. dollar.

Asia-Pacific: China’s Big Engine

Markets in the Pacific Rim have provided a mixed bag so far this year. After a fairly strong first quarter, Japanese markets are sliding, hurt by continued deflation, 100% dependence on oil imports, and political tensions with China, now Japan’s largest trading partner, among other woes.

Lei Wang, an associate portfolio manager at Thornburg Investment Management, believes Japan is simply enduring “the shifting balance of the geopolitical landscape in Asia,” adding that it “needs to adapt, given the presence of its two increasingly influential neighbors, China and South Korea.”

Indeed, South Korea’s market is booming, supported by rising industrial production. Wang noted that the U.S. and China have been the largest consumers of Korean imports, from technology to automobiles. Whether this rally can be sustained could be influenced by the Chinese & U.S. economies, as well as domestic demand, which has been lackluster, he added.

Although it remains a shaky place for foreigners to invest, China remains the world’s leading growth engine due to its rapid internal economic growth and seemingly unquenchable appetite for foreign commodities.

“You cannot understate the importance of China to the global economy,” Hudson said. “One of the major risks looking forward would be if China’s economy were to slow down.”

Europe: West Wanes, East Waxes

Western European markets have been partially hurt by the weakening euro. The recent rejection of the E.U. constitution by France and The Netherlands did little to boost short-term confidence in the currency.

“The euro had a very big move in the fourth quarter of 2004 and the first quarter of this year, so it probably got over-extended,” Hudson said. “The euro was overbought and now, we’re seeing a reversal. As a result, he is looking into more European exporters, since they would benefit from the euro’s depreciation.

However, Wendy Trevisani, a managing director/associate portfolio manager at Thornburg, points out that despite a significant year-to-date decline, the euro remains over 45% higher against the dollar than it was at its bottom, and many European companies are still hurting from this translation to a higher cost base and competition from imports.

“European indices currently trade at lower P/E multiples than U.S. equities,” she noted. “Moreover, growth companies are generally much heavier-weighted in U.S. indexes, while more “deep value” stocks are weighted more heavily in European indexes. So, there are good opportunities to find value in Europe, telecom services being just one example.”

From an earnings perspective, Hudson is tilting more towards Eastern European stocks, where he sees better growth opportunities. “As the continent converges, we’ll see acceleration of growth in Eastern European economies,” he said.

“All the production and capacity of Western European countries are moving to the East because it’s cheaper to manufacture there,” he added. “This gives Eastern Europe faster-growing economies, and more consumer spending power for their people.”

Crude Oil Goes Higher and Higher

One of the greatest risks facing global equities is the persistently high price of crude: Oil has remained above $55-per-barrel, and recently crossed the $60 threshold.

“We don’t think oil prices in the upper $50s is sustainable, although we’ll get some spikes as we have just seen,” said Hudson. “Oil will likely continue to be volatile. And if it underwent a really big spike to, say, $65 or $70, that would cause problems.”

Ed Maran, a managing director/associate portfolio manager at Thornburg, said the uncertainties surrounding the price of oil “is unusually high right now, and that there “are plausible scenarios that are consistent with prices ranging from $35 to $75.”

Oil prices are unlikely to derail the world economy, unless supply fails to adequately meet consumption, Maran added. “So far, the markets have shown great fear, but oil production has consistently exceeded consumption and inventories around the world have risen to near record levels. Right now, there is no shortage of oil and there is no need for price to act as a rationing device.”

Outlook: Foreign Markets Are Still Cheap

In essence, despite some of the twists and turns in global stock markets this year, certain trends remain firmly in place: The U.S. dollar is still relatively weak on a historical basis, foreign equities remain undervalued, and China’s demand for commodities is unyielding.

Jeff Knight, chief investment officer of global asset allocation for Putnam Investments, believes foreign equity markets are also attractive because global economies are rebalancing, shifting away from the U.S. These changes, he noted, are creating an improved business climate abroad, fueled principally by China and the emerging markets. He expects this transformation to continue.

“International equity markets continue to trade at a discount, despite higher GDP growth in regions such as India and China,” notes Trevisani. “In addition, the supply/demand equation has changed over the past few years — there’s been a trend toward global diversification, partly influenced by the weak dollar making foreign investment more attractive. Also, more U.S. investors are putting money abroad, which increases demand and prices.”

However, in terms of allocation, Standard & Poor’s Investment Policy Committee recently reduced its recommended weighting to foreign equities to 15% from 20% of an investor’s overall diversified portfolio, citing that “weakening economies in Europe and, to a lesser extent Asia, may undermine foreign returns while supporting U.S. equities.”

International Equity Funds & Exchange-Traded Funds

Best Performers

Second Quarter 2005 Returns (%)

Worst Performers

Second Quarter 2005 Returns (%)

T Rowe Price Emerging Europe & Mediterranean (TREMX)


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


T Rowe Price Latin America Fund (PRLAX) +16.3 The Japan Fund/S (SJPNX) -8.4
iShares S&P Latin Am 40 Index Tr (ILF) +15.8 Seligman International Growth/B (SHBIX) -7.9
ING Russia Fund/A (LETRX) +14.0 iShares MSCI South Africa Index (EZA) -7.9
AIM European Small Company Fund/A (ESMAX) +13.8 Hartford International Capital Appreciation/B (HNCBX) -7.8

Global Equity Funds

Best Performers Mid-Year 2005 Returns (%) Worst Performers Mid-Year 2005 Returns (%)
Analytic Global Long-Short Fund (ANGLX)


Seligman Global Growth/B (SHOBX)


Tweedy Browne Global Value Fund (TBGVX)


Hartford Global Leaders Fund/B (HGLBX)


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


Prudent Global Income Fund (PSAFX)


Credit Suisse Trust Glbl Small Cap Portfolio (WTVCX)


Eaton Vance Global Growth/C (ECIAX)


Mutual Discovery Fund/Z (MDISX)


Dunham International Stock Fund/Class C (DCINX)


SOURCE: Standard & Poor’s. Total returns are in U.S. dollars and include reinvested dividends. Preliminary data as of 6/30/05.

More of the latest mutual fund news from Standard & Poor’s can be found here.


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