Foreign Markets Can Offer Value to Those Who Have the Stomach for It

Only three years ago, the thinking was nearly unanimous: To have a balanced portfolio, investors needed to include international securities in the mix. Indeed, some suggested that because of the rising influence of foreign markets and the undeniable benefits of such diversification, international investments ought to make up at least one-fifth, or even one-third, of the average American’s portfolio.

Today, after three years of rotten performance--as many foreign indexes have lagged the soaring U.S. stock market--the resolve of these global-leaning pundits has weakened, and, in some cases, reversed. Now, you’re as likely to hear that investing overseas is not necessary. Because big U.S. companies have operations overseas, owning them is good enough--or so the new wisdom goes.

Oddly enough, this intellectual shift may be why investors ought to take a serious look at foreign markets. Popular market wisdom is very often wrong.

“If you got out of America when it was popular [in the 1960s, when U.S. stocks were rising] and into Japan when it was unpopular [around the same time], you would have made a fortune,” says Thomas S. White Jr., president of Thomas White Funds and manager of the Thomas White International Fund in Chicago. “But it doesn’t feel comfortable because you think you know which country is going to do best. Then everybody thought that Japan was perfect in 1989. They did everything right; we did everything wrong. Then they had a bear market for 10 years.”

Admittedly, the only thing worse than investing overseas in the last few years would have been living overseas. Between currency crises, economic and political scandals and upheaval, one market after the next has toppled, while residents in these countries suffered crippling inflation and diminished living standards. Investors--particularly those who participated in the recent declines of the once-bright stars of Latin America and Southeast Asia--are understandably gun-shy.

Still, if you’re able to talk yourself into taking some of your profits out of U.S. stocks and putting the money into depressed foreign markets, you would be following age-old wisdom: “Buy low, sell high.” The strategy makes long-term sense because no one can predict when any market is ready to soar or slump, says A. Michael Lipper, chairman of Lipper Inc., a New York-based mutual fund research and information firm.

Of course, such a move requires fortitude on the part of investors. Not only are they going against the crowd, many are also aware that high markets often go higher before they slump; and if you are trying to buy into a market low, it’s unlikely that you’ll hit the absolute nadir. In other words, you must be confident enough to handle the ridicule from your friends.

On the bright side, fundamental economic indicators suggest that such fortitude will pay off over time, says Jeff Bahrenburg, global market strategist with Merrill Lynch & Co. in New York.

Consider how the value of various countries’ stock markets contrasts with the goods and services that these economies actually produce--two figures that in theory, at least, should move more or less in tandem since stock prices follow corporate earnings. In market-speak, this compares market capitalization--the value of all the stocks trading on a particular exchange--to that country’s share of global gross domestic product--a measurement of all the goods and services that a country produces.

Today, U.S. equities account for more than 50% of the value of every stock trading on every exchange in the world. But U.S. companies produce less than 30% of the goods and services bought and sold around the world.

By contrast, Japan, which has gone through a decade of slumping stock prices, produces about 14% of the goods the world consumes, according to Merrill Lynch. However, the value of the companies traded on Japan’s stock exchange accounts for less than 8% of global market value.

This trend was reversed a decade ago, Bahrenburg notes. In 1988, Japanese stocks accounted for 40% of the value of the world’s corporate shares, while the country produced less than one-fifth of the goods and services consumed around the globe. At the same time, U.S. stock values and its domestic product were nearly in sync.

In light of these figures, Bahrenburg believes that the opportunities for capital appreciation are currently far better in the Japanese market than they are in the U.S.

Japan isn’t the only country that looks to have more potential than the U.S., he says. Developing countries in Asia and Latin America are producing roughly 9% and 5%, respectively, of the goods purchased throughout the world, but the stock prices of the companies that produce these goods amount to less than half that, he says.

Of course, investing in any country outside of the U.S. can take patience, because most of the world’s markets are not as developed and efficient as the U.S., and as a result, they can often swing widely in value. (For detailed information about currency risk and the various vehicles available for investing overseas visit, http://161.35.110.226/home/business/invest101/story7.htm.)

While Bahrenburg believes that Latin America’s near-term economic future still looks dicey, he’s bullish about most parts of Asia, neutral on Europe and “underweighted” in the U.S.

“We like all the major areas of the world better than we like the U.S. right now,” he adds.

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The American Premium

Is a particular stock market overvalued or undervalued? One way to analyze the question is to compare the value of company stocks trading on various exchanges around the world with the value of all the goods and services that those economies produce. This analysis, compiled by Merrill Lynch & Co. of New York at year-end 1998, indicates that the U.S. market is comparatively overpriced, whereas Japanese stocks are trading cheaply.

U.S.:

Market cap*: 50%

Global output**: 28%

Japan:

Market cap: 7%

Global output: 14%

Europe (France, Germany, Italy, Spain and Britain):

Market Cap: 18%

Global output: 28%

Latin America (Argentina, Brazil, Chile, Colombia and Mexico):

Market Cap: 2%

Global Output: 6%

*Value of all stocks as a percentage of the world’s total

**Global output figures are as of year-end 1997, which is the most recent statistics available.

Source: Merrill Lynch

*

This and previous articles in the series can be found online at http://161.35.110.226/invest201. Times staff writer Kathy M. Kristof’s earlier series, Investing 101, can be found at http://161.35.110.226/invest101. Write to Kristof in care of Personal Finance, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053, or e-mail her at kathy.kristof@latimes.com.