Rytoft says this trend is real and ongoing. He says Europe, which had a correlation of 0.82 with the Standard & Poor's 500 a year ago, has increased to 0.89 during 2004, according to Bloomberg data. "The fact is that the world is getting smaller, basically," he says. "Globalization is going on, and this means there is growing correlation with U.S. markets."

    Rytoft notes that it is the globalization of equity trading, not just of trade, that is spurring this trend. "It doesn't matter where you sit in this world, you can always trade stocks, at any time," he says. "Opportunities for arbitrage, any market inaccuracies, are taken advantage of immediately. So therefore we are seeing this increase in correlation."

    One between-the-lines read on the trend is that as companies around the world grow and mature, they recognize the need to attract international investment, says Krosby. Which means that they increasingly are becoming more like us.

    "As companies in Asia, for instance, want a broader range of investors, they're becoming more transparent," says Krosby. "They're understanding the concept of shareholder value. And as that trend continues, the money will find those companies. Say in Japan, even during their worst period, when it looked like they would never emerge from their deflationary spiral, there were a number of companies that offered marvelous opportunities. Because, despite the host of problems in Japan, those companies understood that they needed to restructure themselves."

    Krosby says advisors and their clients should be looking to fund managers to search for bottom-up changes-what is happening at the corporate level-and not just the top-down actions by governments. "Even though we see the markets moving more closely together, investing in international equities is the one way to get exposure to companies that are restructuring, regardless of the headlines about the countries they are in," she says. "That's the job of the international portfolio managers, to find those companies."

The Lure Of Emerging Markets

The trend to closer correlations has led many to emerging markets and small-cap international equities, accepting the higher risk in exchange for higher potential profits. "The way we believe you get the biggest bang for your diversification buck is with international small-caps," says Orecchio.

    While economic growth in Europe is slower than in America's, other regions offer significantly higher growth. "I think emerging markets probably look more attractive than developed overseas markets," says Eve Kaplan, who spent 20 years living in Asia and working as a portfolio manager, stock analyst and fee-only advisor before returning to the United States and starting a solo practice, Kaplan Financial Advisors, in Berkeley Heights, N.J., as a newly minted CFP certificant. "I wouldn't warn people away from developed overseas markets, but I do think there is more opportunity on the emerging side."

    But the enthusiasm is tempered by an appreciation of the risks in emerging markets, and particularly of small-cap companies in those markets. "Emerging markets are very attractive," Rytoft says. "But there's a reason they're called emerging markets. Things can happen."
   
    Advisors maintain it's important not to downplay the risks of venturing into nations and regions where their experience with the rule of law and free markets has been brief, and that they depend on the professionalism of the international funds, and the spreading of risk across funds, to provide balance and security. "We broadly diversify among countries and issues," reducing the impact of the inherent volatility, says Orecchio. "So if someone has a problem, like Malaysia in 1998, you're not hurt that much. ... We're buying the basket of stocks, not individual stocks."

    Krosby says advisors and clients should be looking for funds that offer a safe way to gain emerging market exposure. "In a true international fund, the portfolio manager typically has the ability to hold 10% to 20% of the portfolio in emerging market stock, typically on an opportunistic basis," says Krosby. "That gives the client exposure without truly being in an emerging market fund."
   
    World events are leading to what may be considered a new type of market, something between the typical emerging market and the developed countries.