Returns of foreign stock funds eroded for U.S. investors as the dollar gained against foreign currencies in the first half of the year.
Even though most global equity markets made modest gains in local currencies year to date, many have declined in dollar terms. For example, markets in the euro zone gained about 7% in local currency, but saw around a 5% drop in dollar terms.
Indeed, after a three-year decline, the U.S. dollar, which seemed to have bottomed out at the end of 2004, become resurgent again. Through the first half of 2005, the dollar gained roughly 5% against the yen, and 10% versus the euro.
The dollar's reversal has thrown a new wrinkle into foreign stock-picking as investors are already grappling with high oil prices, rising U.S. interest rates, and a possible slowdown in the global economy.
The average international stock fund gained just 0.57% for the first half of 2005, while the average global equity portfolio, which can also invest in U.S. stocks, edged down 0.19%. In the second quarter, international stock funds rose 0.25%, while global stock funds picked up 1.4%.
Latin America: Rich on Commodities
Funds investing in South America have delivered among the highest returns so far this year, reflecting strong performance in the two biggest Latin economies, namely Brazil and Mexico. High commodity demand from China has been a driver.
Matt Hudson, manager of the American Century Global Growth Fund (TWGGX), noted that when the commodity cycle peaks, it will hurt countries like Venezuela, Brazil and Mexico disproportionately. But this has yet to happen.
Despite robust returns in Latin America, investors should remember it is still an emerging market, and susceptible to high economic and political volatility. For example, Brazil's government is in the midst of a political bribery scandal, which could conceivably slow down fiscal reforms, and turn off foreign investors. "This exemplifies one of the risks of emerging market investing," Hudson said. "There is a reason why valuations there tend to remain low, because of the inherent volatility and political risks."
To illustrate the point further, high crude prices have actually not helped oil producer Venezuela. The country's equity markets have declined sharply amidst endless political turmoil. Oil-rich Mexico presents less of a risk since its steadily strengthening economy is more closely tied to the U.S. . In addition, the peso has actually appreciated against the U.S. dollar.
Asia-Pacific: China's Big Engine
Markets in the Pacific Rim have provided a mixed bag so far this year. After a fairly strong first quarter, Japanese markets are sliding, hurt by continued deflation, 100% dependence on oil imports, and political tensions with China, now Japan's largest trading partner, among other woes.
Lei Wang, an associate portfolio manager at Thornburg Investment Management, believes Japan is simply enduring "the shifting balance of the geopolitical landscape in Asia," adding that it "needs to adapt, given the presence of its two increasingly influential neighbors, China and South Korea."
Indeed, South Korea's market is booming, supported by rising industrial production. Wang noted that the U.S. and China have been the largest consumers of Korean imports, from technology to automobiles. Whether this rally can be sustained could be influenced by the Chinese & U.S. economies, as well as domestic demand, which has been lackluster, he added.
Although it remains a shaky place for foreigners to invest, China remains the world's leading growth engine due to its rapid internal economic growth and seemingly unquenchable appetite for foreign commodities.
"You cannot understate the importance of China to the global economy," Hudson said. "One of the major risks looking forward would be if China's economy were to slow down."
Europe: West Wanes, East Waxes
Western European markets have been partially hurt by the weakening euro. The recent rejection of the E.U. constitution by France and The Netherlands did little to boost short-term confidence in the currency.
"The euro had a very big move in the fourth quarter of 2004 and the first quarter of this year, so it probably got over-extended," Hudson said. "The euro was overbought and now, we're seeing a reversal. As a result, he is looking into more European exporters, since they would benefit from the euro's depreciation.
However, Wendy Trevisani, a managing director/associate portfolio manager at Thornburg, points out that despite a significant year-to-date decline, the euro remains over 45% higher against the dollar than it was at its bottom, and many European companies are still hurting from this translation to a higher cost base and competition from imports.
