Through the 1980s, stock markets in Europe and Japan left Wall Street in the dust. So by the '90s, spicing portfolios with foreign stocks was as natural for savvy U.S. investors as putting salsa on their eggs. But the great U.S. bull market changed everything.
After that, international diversification seemed to bring risks with little reward for U.S. investors, and the U.S. became the top foreign destination for everyone else. While Japan's markets remained paralyzed after its real estate and equity bubble burst in 1990, the Standard & Poor's 500-stock index rose an average 15.7% a year in the 1990s. The rest of the world, measured by Morgan Stanley Dean Witter & Co.'s Europe, Australia, and Far East Index, trailed, with a 7% rise in dollar terms.
When the bull market crashed in March, 2000, most of the world's bourses fell too. The broader S&P's 7% drop so far this year still matches or beats the performances of the world's top markets. Add to that the effects of a strong dollar. They obliterate all but the most spectacular gains of euro-denominated stocks for U.S. investors, for example--and it's abundantly clear why international diversification became the investing equivalent of cod-liver oil for them: If it's good for you, why is it so unrewarding?
CLOSE-RUN RACE. Investment advisers admit that it's awfully hard to tell investors to put up and wait 10 years. "If one looks at valuation or the likelihood of growth re-emerging to help on the earnings and revenue side, the U.S. has the most going for it," acknowledges Larry Hatheway, managing director of global asset allocation for UBS Warburg in Stamford, Conn.
That doesn't mean people should shun the rest of the world long-term. No market or asset class reigns forever: Witness Japan or dot-coms. "There are people who say the dollar is today what the Nasdaq was 15 months ago," cautions Jean-Marie Eveillard, portfolio manager for the First Eagle SoGen Overseas and Global Funds, which have a combined net asset value of over $2 billion. For average annual returns in dollars over the entire 1970-99 period, Europe, Japan, and U.S. are close--14% for the first two and 11.2% for the U.S.
Still, says Nicholas P. Sargen, global market strategist for J.P. Morgan Private Bank, advisers are lazy to fall back on the 30-year perspective. Market conditions have changed so much, he says, that fund managers can't just track the EAFE index. They need to seek the best companies, as J.P. Morgan's Global 50 Fund does. "What's magical about EAFE?" Sargen says. "There's still a case for international exposure on a tactical basis. But I'm not satisfied with the argument that it's a long-term thing."
IN LOCKSTEP. The problem is that diversification isn't what it used to be. Globalization has scrambled the tidy criteria that money managers once used to pick an international portfolio. A company's national origin is no longer the proxy for its risk profile that it once was in most industrial countries. Now, except for those of Japan, such countries' economic policies are closely aligned--even linked, in the case of the 12-nation euro zone. So world markets tend to move in tandem, and foreign investment, especially index investing, offsets domestic risk less than it once did. Also, it's possible to get international exposure without leaving the U.S. Sectors such as telecoms, pharmaceuticals, banking, and oil are so global that many analysts no longer look at them on a country basis.
Even the bluest U.S. blue chip is exposed to overseas risk. At the same time, foreign companies may be more American than they look and may be cheaper. That's the case with French insurer Axa, which controls U.S. asset manager Alliance Capital Management, says Christopher Wolfe, equities strategist for J.P. Morgan Private bank.
Country differences have not disappeared. Bryan Allworthy, head of systemic analytics at Merrill Lynch & Co. in London, says his research shows that "the national characteristics [that move stocks] are rapidly falling away" in Europe, but regional factors remain important. Global investing is still "about themes and building positions over time," he says. Merrill tells its clients to focus on growth because the world's central banks are intent on restarting the global engine. He likes cyclicals--such as oil major Royal Dutch/Shell Group, which has a 2001 p-e ratio of about 17, vs. 18.2 for Exxon Mobil Corp.
Others say the best opportunities abroad aren't in the levelling path of globalization. First Eagle's Eveillard, who views the weak euro as a buying opportunity, looks for companies with simple, stable businesses or that have anomalies in structure and valuation that are rare in the U.S. He looks for holding companies whose market capitalization is less than the value of their assets. He cites Spain's Corporacion Financiera Alba, which holds 3.5% of French supermarket company Carrefour. It trades at a 40% discount-to-net-asset value. Eveillard's top stake is more than 7% of Buderus, a residential boilermaker whose share price has doubled over 15 months in euro terms.
Utilities, especially monopolies, also track local trends. J.P. Morgan's Wolfe likes National Grid Group PLC, which runs the British power network. National Grid's p-e ratio based on fiscal 2002 earnings is 22.4. Its shares are down about 14.3% year-to-date in dollars, but Wolfe says it will gain from rising energy use as Britain's growth picks up. Christopher Ong, executive vice-president and head of Asian equities at BT Funds Management in Sydney, likes Hong Kong and China Gas Co. The fast-growing Hong Kong-listed company benefits from China's switch to cleaner energy.
Globalization is changing the rules for investing. Even the pros are struggling in the new environment. The U.S. won't be king forever. But it's hard to be patient.
By Julia Lichtblau, with Heidi Dawley in London, Becky Gaylord in Sydney, and bureau reports