Overseas Stocks Look Cheap Again

02/03/2009 12:00 pm EST

Focus: MARKETS

Tim Middleton of MSN Money says foreign stocks are so out of favor now that they are very attractive for US investors.

US investors dumped foreign stocks in droves last year, and for good reason: The dollar rose, and global economies fell.

A rallying US dollar meant many foreign companies earned smaller returns because their local currencies were worth less. Even economies that had been outpacing the US for years weren't immune.

That's a big reason the average foreign-stock mutual fund in the Morningstar database crumpled 44.9% in 2008, compared with the 38.5% decline of the Standard & Poor's 500 Index.

But while some foreign currencies are still weak, the dollar's ascent has paused. And that could again make overseas stocks one of the most attractive areas for investors in 2009. The global growth story paused, but the world isn't going away.

Meanwhile, foreign policymakers have undertaken stimulus packages on a par with those being adopted in the United States, albeit somewhat more tardily. Combine that development with the dollar's slip, and any foreign-stock obituary looks premature.

On a percentage basis, investors cashed in twice as many shares of foreign-stock funds as domestic stock funds in 2008. But anyone still fleeing global stocks could be closing the barn door after the horse has bolted.

Overall, though, the world still seems to be underperforming the US The MSCI EAFE Index, the broadest measure of foreign developed markets, was down 11.5%, and the MSCI Emerging Markets Index was off 9.2%, compared with the 7% decline of the S&P 500, the 6.2% loss of the Dow Jones Industrial Average and the 4.4% decline of the Nasdaq Composite Index.

The dollar rally has paused, almost certainly because interest in US Treasury bonds is waning due to their now-miserly yields. If this leads foreign investors to desert Treasuries, the dollar will fall harder—especially in the face of federal deficits that will likely surpass 8% of gross domestic product within 18 months.

A broad mutual fund is likely your best play right now because shopping for overseas stocks or even the right market is particularly tough.

Foreign developed markets will deliver US-size returns that are not entirely synchronized with the domestic market because they are subject to similar but not identical risks. Investing in them makes your portfolio more diverse.

Foreign emerging markets will deliver above-US returns because they are smaller, faster-growing and much riskier.

At the bottom of a bear market, which is where we find ourselves, fewer and fewer investors have confidence that normalcy will be restored. It will, and front pages two years from now will report that foreign-stock funds are soaring. If only you could have gotten in at the bottom.

You can.

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