A world of difference, weaker dollar boost foreign markets

According to Bill Montague, of Smith Barney's Consulting Group, U.S. investors are once again taking a closer interest in foreign affairs and foreign markets. After largely shunning international stocks following the collapse of the dot-com boom and the 2001 terrorist attacks, investors are now pouring money into them at a record pace.

Helping drive the trend: an economic upswing overseas - particularly in the developing countries of Asia and Latin America - and a decline in the value of the U.S. dollar. Over the two years ending last December, the green back shed roughly 20 percent of its value against the euro and almost 14 percent against the Japanese yen.

A weaker greenback tends to lift foreign returns for U.S.Ðbased investors by increasing the dollar value of stocks and bonds denominated in local currencies. For example, Morgan Stanley Capital International's Europe Index returned 21.4 percent in dollar terms in 2004, even though the index gained only 12.7 percent in Euros.

As always, eye-catching returns have proven a magnet for many individual investors, who often can't seem to resist the urge to chase recent short-term performance. Fund flows into international equities total more than $60 billion in the first 11 months of 2004, easily topping the previous peak set back in 2000.

This isn't the first time U.S. investors have sought adventure in foreign lands. Flows to emerging markets surged in the early 1990s, only to dwindle abruptly after the Asian financial crisis. Interest in international markets briefly revived in 2000, when some foreign telecommunication stocks were lifted by the dot.com bubble. But the collapse of the boom, followed by the 2001 terrorist attacks, led many U.S. investors to retreat to home ground.

Now the tide has turned again. Some analysts suggest the lure of international markets could prove more lasting this time, in part because of the economic forces-such as the huge U.S. trade deficit - weighting down the dollar. Many foreign economies also have lagged behind the United States in their recovery from the 2001-02 recession. As they catch up, overseas earnings growth could accelerate.

Exchange rates, however, are volatile and notoriously difficult to predict. A sudden dollar rebound could easily offset a rise in foreign stock prices in local currency terms. If the dollar remains weak, some foreign companies could suffer- particularly those that depend heavily on exports to the U.S. market. Chasing short-term international performance could have disappointing long-term results.

Ultimately, the strongest argument for international diversification may have les to do with statistics such as correlation and standard deviation and more to do with the growing importance of non-U.S. markets. For many investors, foreign equities have simply become too big an asset class to ignore.

According to MSCI, non-U.S. equities accounted for almost half of world stock market capitalization at the end of 2004. That's up from just 34 percent in 1970, when EAFE Index was launched.

Although globalization is tightening the connections between U.S. and foreign markets, international diversification still makes sense for many - though not all - investors. However, a rapidly changing environment may require new investment techniques. Some investors may benefit from an approach that stresses global industries and sectors, rather than regional and national markets.

Given the uncertainties and risks of this ear of rapid change, its all the more important for investors to have the information and advice they need to make intelligent decisions. By working with your financial adviser, investors can better determine what role international can play in your investment portfolio.

For a full copy of Consulting Group senior financial writer Montague's report, please call 689-8704 or e-mail william.a.creekbaum@smithbarney.com.

• William Creekbaum, MBA, CFP, a Washoe Valley resident, is senior investment management consultant of SmithBarney, a financial services firm serving Northern Nevada at 6005 Plumas Street, Ste. 200 Reno, NV 89509.