Time to Nibble Overseas?

09/08/2011 9:42 am EST

Focus: GLOBAL

Igor Greenwald

Chief Investment Strategist, MLP Profits

Foreign stock markets are having a miserable year, but valuations and sentiment point to better days ahead, writes MoneyShow.com senior editor Igor Greenwald.

Investing under the best of circumstances is hard enough, and of course these days it’s considerably harder.

Sending money overseas imparts a further degree of difficulty. Information can be scarce even when the investor understands the language. Disclosure rules are different. There is currency risk. And the investing climate is subject to rapid political change, though the past summer’s goings-on in Washington, D.C. should make Americans feel at home in any banana republic.

All that additional uncertainty and extra work had better bear fruit, or we tend to quickly lose interest. In the US, overseas investing didn’t really take off until foreign markets started delivering outsized returns in 2003-2004, marking the beginning of the end of US economic supremacy.

It was a nice run, until the 2008 collapse hit foreign stocks and emerging markets especially hard. Many of those markets rallied just as hard in 2009, of course, only this time without so many US investors.

Lately, though, parochialism has been a virtue. Most of the headlines from abroad this year have been bad, yet not as bad as the price action.

Europe continues to teeter on the brink of a banking crisis, and has been threatening to drag the rest of the world down with it.

Upheaval in the Arab world, inspiring as it’s sometimes been for those of us who still believe in democracy, caused oil and grain prices to jump, contributing to the springtime economic slowdown.

Disaster-stricken Japan remains something the rest of the developed world hopes not to become.

China is tumultuous, corrupt, and racing against time to shift to a development model less reliant on cheap exports and centrally planned building sprees. Across emerging markets, interest rates and inflation have been on the rise, with no guarantees that the mostly untested central banks will manage to engineer a soft landing.

Rapidly developing economies are especially prone to booms and busts, and many of their stock markets have been trading as if the next bust is just around the corner.

Emerging markets are down 13% so far this year, and developed markets excluding the US have done a bit worse at -15%, according to MSCI Barra. In dollar terms, those two measures are down some 12% apiece, so it’s not like as if the greenback’s gradual decline has been much of a silver lining.

Many prominent markets have had a particularly hard time. Japan and China are down 13% apiece on the year in dollar terms, Brazil 18%, and India 20%.

Outside of Africa and the Caribbean, only three stock markets—New Zealand, Indonesia and Thailand—are currently in the black for 2011. Most of the rest make the S&P 500’s 4.7% year-to-date haircut look good.

Meanwhile, the volatility has become close to unpalatable. Even after regaining 4% yesterday, German stocks were still down more than 6% for September and 26% in three months.

No wonder most MoneyShow.com readers are looking to deploy their investment dollars closer to home. In a recent poll, just 15% identified foreign equities as their favorite asset class (split evenly between fans of developed and emerging markets). In contrast, 32% were most bullish on large-cap US stocks.

That’s quite a turnaround from February 2010, when foreign stocks were favored by 33% in a similar poll after the rally of 2009. And that was, in turn, quite a turnaround from the derisory 2% that foreign equities had polled a year earlier.

Current sentiment falls smack in the middle between those two extremes, but there are other reasons to believe investor confidence is pretty low. Earnings multiples in the once hot markets of China and Brazil are way below their historical mean, suggesting a high degree of uncertainty.

Crucially, most emerging-market governments have the financial wherewithal to cushion their economies during a downturn. But they may not let it come to that. Brazil’s central bank recently cut rates by a half-point after a lengthy run-up, and China’s tightening may also be at an end.

Meanwhile, emerging economies will continue to make the world go round: Morgan Stanley estimates they will account for 80% of the global GDP growth this year and next.

With expectations so subdued and prospects relatively robust, this is a good time to do some selective nibbling. I’d look to the sectors geared to emerging consumer demand.

And I’d look especially hard at China, where the appreciating yuan will boost consumer purchasing power faster than the economy grows, and where the government has the incentive and the means to kick the problem of bad bank loans down the road.

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