Float Your Bucks

By Daniel Kadlec

I'm as willing as the next guy to debate whether it's smart to invest in foreign stocks--but not now. Time is wasting. A weakening dollar and an abundance of cheap foreign pickings have whipped up a tail wind that U.S. investors can't afford to ignore. Yes, you can argue that the diversification benefits of foreign investing aren't what they used to be now that the world's economies are so intertwined.

In the past three years, U.S. stocks have fallen an average 16% a year, and foreign stocks have fallen even harder. But there is no question that foreign markets can outperform the U.S. for years at a clip, and it looks as if we're entering just such a period. The falling buck is a big part of that. As the dollar weakens, foreign stocks held by U.S. investors become more valuable because the underlying foreign currencies appreciate.

In the 12 months that ended Jan. 31, stocks in the U.S. fell an average 23%, while stocks in Europe fell 32%. But because the dollar weakened--down 20% against the euro--U.S. investors would have been better off in European stocks, which in dollar terms lost only 18%. What lies ahead? Forces that have been knocking down the dollar remain in place, notably a growing trade deficit and a run of terrible investment returns on dollar-based assets that are scaring foreign investors into keeping their money at home. Looking ahead a year, many pros believe the buck will be 5% to 10% lower against major currencies.

Meanwhile, the global economy should start to perk up now that companies around the world have used three lean years to shed fat and restructure. Foreign stocks were hit harder and are cheaper relative to earnings potential than stocks in the U.S. "The U.S. has to turn first," says Barton Biggs, chief global strategist at Morgan Stanley, because it remains the world's leading economy. "But then Europe and Asia will move further, faster," he predicts. His favorite regions are parts of Europe--notably Germany, France, Italy and the Netherlands--Hong Kong and South Korea, and emerging markets Thailand, Malaysia and Indonesia. Stocks in these markets trade at less than 10 times expected 2003 earnings, on average, while U.S. stocks still carry an average P/E ratio of around 20. A few themes stand out:

--CHINA Benefiting from this country's 8% growth rate, companies in emerging Asia will blossom, and their stocks, says Biggs, will outperform "in a big way." The safest direct play is through Hong Kong, where China's big companies trade. Wendell Perkins, who manages the Johnson Family International Value fund, one of the better-performing funds of the past three years, likes China Petroleum and Chemical (Sinopec), whose stock is up 25% in the past 12 months, and the rapidly growing Asia Satellite Telecommunications Holdings (down 34%), which sells satellite time for broadcasting and telecom use. Shares of both trade as ADRs on the New York Stock Exchange and have P/Es under 10. Sinopec, Perkins notes, is a healthy blue chip with a dividend yield north of 6%.

--NATURAL RESOURCES The price of metals and other raw materials is rising. Bernard Horn, manager of the Polaris Global Value fund, is overweighting resource-rich South Africa and buying the stocks of materials companies around the globe like paper firms Sappi in South Africa (ADR up 18% in the past 12 months) and Svenska Cellulosa, or SCA, in Sweden (ADR up 8%). Other countries rich in natural resources and poised for outsize benefit are Australia and Canada.

--CHEAP EUROPE Germany is especially attractive; its stocks have been among the hardest hit because so many are economically sensitive. Volkswagen, with a P/E of 6, is one of Perkins' favorites.

A good way to invest around the world is through a well-run global mutual fund. I would consider Oakmark Global, a no-load fund that plays the value game successfully, and broker-sold First Eagle Global, which has a good-size stake in industrial-materials stocks, the kinds that are most leveraged to a recovery. And one last but important point: some foreign funds spend money hedging against currency moves. Check yours because you don't want that. In the short term, the trend is in your favor, and long term it all evens out.