A weak U.S. dollar, strong performance prompt renewed interest.
Could international stocks be ready to outperform U.S. stocks for the first extended period since the 1980s?
David Warren, co-manager of the T. Rowe Price Interna-tional Fund, thinks so. Equity valuations abroad are not quite as attractive as they were a year ago, he observes, but they still favor non-U.S. companies.
"Most economies look as though they are in a growth phase," he says. "There is increasing likelihood of a synchronized global recovery that is more pervasive than we have seen in a long time."
The key driver of overseas equity performance will be the strength of the earnings recovery, how soon interest rates begin to rise and continued modest weakness of the dollar, Warren believes. The economic expansion in the United States should provide a tailwind, particularly in Europe. "The weakening dollar has played a major role in the outperfomance of non-U.S. equities over the past 24 months," he says. "That trend should continue, given the U.S.'s huge current account deficit and less U.S. investment by foreign investors."
George Greig, manager of the William Blair International Growth Fund, agrees. He likes Asia, which makes up 20% of his fund's holdings. "Asia performed well last year and will surprise on the upside this year and outperform the rest of the world," Greig says. "The region's economy is balanced. Balance sheets are solid, and currencies are well supported." Greig adds that Europe will benefit from global economic expansion, but will suffer from lagging profit growth and structural problems within the European Economic Union.
Investing worldwide can be risky. There is a lack of liquidity in emerging markets. There is geopolitical risk due to the threat of terrorism. In Asia, the problems with North Korea, unstable governments and banking systems could cause trouble. In addition, the international markets are highly correlated with the United States, so the fortunes of the overseas markets could rise and fall with the United States.
Historically, most periods of international outperformance coincide with a weaker U.S. currency, says Tom Sowanick, global strategist with Merrill Lynch in New York. However, the emerging markets of Indonesia, Thailand, Chile, South Africa, Russia, Hungary and the Czech Republic have outperformed when the dollar is weak. By contrast, Korea, Taiwan, Mexico and Israel have outperformed when the dollar is strong.
The Asian markets registered stellar returns in both local currencies and U.S. dollars, averaging more than 56% last year in local currencies and 57% in U.S. dollars. But Mark Headley, manager of the Matthews Asia Pacific Fund, looks for stock prices to pull back.
"The biggest risk is that we have had a fabulous market run and need some bad news to test things," he says. "We are also going to face political tensions all over Asia. Taiwan, Indonesia and North Korea could flare up at any moment. In Japan, the question is if the country is recovering on a structural basis. Or is it a cycle bounce followed by another recession?"
Asia also is heavily influenced by the U.S. economy. One of the greatest threats: If the U.S. economy slips and consumption declines. Furthermore, rising U.S. interest rates could have a negative effect on the region.