The Case for Investing Internationally

Many countries are growing faster than the US, and when global markets do rebound, they'll show individual strengths you'd be wise to have bet on. Just when more investors were warming to the benefits of global investing, global stocks tanked. When the Standard & Poor's 500-stock index fell ~ 40% last year, the damage outside the US was worse—and in emerging markets, it was devastating – with international markets down 50-60%, on average.

The severity of the downturn internationally convinced many investors that a basic argument for diversifying overseas, or decoupling, was no longer valid. Decoupling is the idea that foreign countries have large enough domestic economies that they are insulated from a financial shock or recession in the US. With that concept seemingly debunked, investors steered clear of foreign markets. Making matters worse for investors who had sent money overseas, currencies turned against them. In the boom years, a weakening dollar hiked returns when overseas investments held in Euros or rupees were sold and converted back to dollars. Until the Federal Reserve's latest rate cut and corresponding fall of the dollar, a strong dollar had done the opposite.

There are good reasons to stay invested overseas. The US represents less than half of global market capitalization or overall stock market wealth, and many overseas countries (especially Brazil, India, and China) continue to grow at a faster rate than the US. Over the long term, adding foreign stocks decreases investment portfolio volatility and increases returns. So for those who want to add to foreign holdings, or want to get in for the first time, depressed equity prices offer a chance to buy globally on the cheap. Finally, while markets tend to track each other more tightly when investors are afraid of their own shadows, as the global economy turns up, markets will reflect their individual strengths. Just because stocks in the US and China, say, move in the same direction doesn't mean they're doing so at the same rate, with the same returns.

While it's not the case that the US is going to go through a painful recession and the rest of the world will go its merry way, other countries will hold up better. One hurdle for the US is that consumers have too much debt. Other countries, such as those in Asia, don't have those same imbalances. When this cyclical headwind starts to ease up, these longer-term imbalances won't hold them back as much. US investors should add exposure to foreign stocks as most have too high of a weight in the US relative to global markets.

The percentage of your stock portfolio (excluding allocations to bonds and other asset classes) that should be overseas depends on your age and risk tolerance. Many advisers recommend 20% to 35%, with more going to developed markets in Europe and Asia and less going to emerging ones, such as China, India, and Brazil. I am a big believer in overseas investing for the long term. But in the short term, the aggressive approach the US has taken to tackling its problems will lead it out of recession sooner than other developed countries, particularly those in Europe, where the response has been more sluggish. The emerging markets are recovering at a much quicker rate.

While I am feeling more comfortable that a recovery is underway in the US, there will be a point where investors around the world will feel more certain, and you will start seeing assets moving to their own rhythms. Those hurt the most by falling foreign markets are the ones who rushed in at the peak. Invest for the long term now, and you will ride the markets back up. If you're taking a really long-term view, there is greater long-term growth outside the US than in it. It probably won't be reflected in global equity prices for another year, but you'd better not give up on overseas, especially emerging markets, just because of what happened in 2008.

CHINA’S GROWING APPETITE (for commodities, not Treasury bonds)

If the advances in commodities were being driven mainly by US demand, there would be less worry that inflation might stymie growth. That’s not what’s happening this time, US investors have poured more than $6 billion into commodities this year given their strong attraction to raw materials and energy plays. What’s pushing up commodities is growth elsewhere, particularly in Asia. Commodities have surged as China’s government said property sales and investment are accelerating, adding to signs that the world’s 3^rd largest economy is recovering. India’s economy grew at a 5.8% annual pace in the first quarter of 2009, and China’s at a 6.1% rate. According to analysts, China’s GDP is forecast to grow as much as 10% in the 4^th quarter of 2009.

Additionally, the Chinese government has already shown its fears of US inflation by purchasing more precious metals to balance its reserves. A shift from hard currency to precious metals is a classic hedge against inflation. This shift will produce two effects. By shifting to metals, the Chinese have decreased their demand for US dollars and bonds. Also, the increase in metal purchases will drive up the price of metals everywhere. China is the world’s biggest consumer of iron ore, rubber, copper, tin and zinc. Many of these metals are crucial in the production of durable goods. This will certainly lead to price increases in the goods produced by these commodities as well.

The rapid recovery in giant Asian economies such as China and India is fueling an increase in commodity prices, raising the specter of inflation as the recession continues. As if General Motors did not have enough to worry about, a 60 % jump in gasoline prices this year may cause inflation to soar and throw another roadblock in the way of recovery. It isn’t only GM’s sales that might suffer. Higher energy costs helped trigger a 20 % rise in a Standard & Poor’s GSCI Total Return index in May, the biggest monthly percentage gain since September 1990. That index tracks metals and agricultural commodities as well as energy and has surged 39 % since touching an almost seven-year low on Feb. 18.

Copper has climbed 59 % this year on the New York Mercantile Exchange to $2.28 a pound as of June 5th. Gasoline is up to an average $2.65 a gallon in the US at the beginning of June from $2.05 on May 1st. A 50-cent-a- gallon markup removes about $70 billion from consumers’ annual spending power, says James Hamilton, a professor of economics at the University of California, San Diego. Prices still remain short of the $4.11 record set on July 15^th of last year when crude oil reached $145 a barrel, which helped push annual inflation in July 2008 to 5.6 %.

The commodity increases are a burst of inflation that could sap demand just as the US economy is starting to right itself. We could end up with stagflation which could stifle the recovery.

Green Valley Wealth Advisors | June 15, 2009

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