Where to Strike as the Dollar Droops

While the greenback is down, bourses everywhere are up. But that hardly makes foreign equities a sure thing

After years of seeing gains eaten away by a climbing dollar, investors in foreign equities have reason to cheer their returns in the first half of this year. A plunging greenback has delivered stellar gains in dollar terms on bourses from São Paulo to Frankfurt to Sydney to Moscow. But while the dollar may continue to weaken, there's no guarantee it won't bounce back in the second half and erase all the advances.

Those currency swings are what makes picking foreign stocks so tricky. Finding long-term plays can be particularly tough in Europe, where a euro rally has boosted stock prices in dollar terms but has hurt some companies' earnings by making their products' prices less competitive. "It's a two-edged sword," says Jim Moffett, portfolio manager of UMB Scout WorldWide Fund in Kansas City, Mo. His strategy in Europe is to focus on businesses that earn most of their revenue in their home markets. He likes Spanish oil company Repsol YPF and Austria's OMV, both local powers in refining and marketing retail products such as gasoline.

Of course, currency isn't the only risk associated with European equities. Other dangers include signs of deflation in Germany and recession in the rest of Europe, says Patrik Schöwitz, global strategist at HSBC Bank (HBC ) in London. To put a lid on negative earnings surprises, he favors companies whose revenues prove stable in good times and bad, like London-based beverage and confection maker Cadbury Schweppes (CSG ) British distiller and beermaker Diageo (DEO ) also provides good protection against an economic slump with its excellent cash flow and "excessively low valuations," says David Herro, manager for the Oakmark International Fund.

Well-managed companies with strong brands should be able to ride out the current economic weakness as well. Consider luxury-car maker BMW, says Georg Stürzer, analyst at German bank HVB. The manufacturer of the ever-popular Bimmer plans to expand annual sales by 40% over the next five years by rolling out new models such as an updated 5-Series sedan. "It will be one of the best performers because of its slick advertising and determined marketing campaign," says Stürzer.

While many economies in Europe are slowing, economists say strong domestic demand in Russia is expected to deliver solid 6% growth in its gross domestic product this year. To take advantage of that growth, Peter Boone, head of research at Brunswick UBS in Moscow, recommends Moscow City Telephone Network (MGTS ) which controls 90% of Moscow's land-line phone market. Boone is also keen on VimpelCom (VIP ) Russia's No. 2 mobile-phone operator, which is set to benefit from rising consumer incomes and regional expansion. "Its valuations are pretty attractive," Boone says.

Among retailer stocks, Mark Mobius, head of Templeton Emerging Markets Fund, likes Russian dairy company Willbinndann because it provides exposure to "the domestic consumer revolution." Two other Russian favorites are Yukos (YUKOF ) and Sibneft (SBYYY ). They plan to merge at the end of this year to create the world's fourth-largest oil company. That should lead to even faster growth, says Alexander Branis, director of Moscow-based equity fund Prosperity Capital Management. "It's going to be a very large company, on par with global supermajors," he says. "So it's impossible for investors to ignore."

On the other side of Siberia, in Japan, the climate remains chilly for investors. Sick banks, worsening deflation, and flat prospects for economic growth all make for a grim picture. Still, the benchmark Nikkei stock index recently rebounded strongly from its 20-year low, and a few bright spots shine amid all the gloom. For instance, recent restructuring is paying off for heavyweight Matsushita Electrical Industrial. The company, which sells consumer electronics under the Panasonic brand, reported operating profits of $1.06 billion on $62 billion in sales for the fiscal year ended in March. Matsushita Electric's profit reversed a $1.6 billion operating loss in fiscal 2001, thanks to job cuts and sales of video cameras and its new DVD recorder DIGA, which has been a smash hit in Japan. "The company has been able to double its global market share in video cameras, raising sales by 25% while the industry declined 16% year-on-year," says Hideki Watanabe, analyst for HSBC Securities in Tokyo.

Office equipment maker Canon is also making global gains. It continues to expand its world market share in photocopiers and digital cameras. Sales in these two key sectors helped boost first-quarter sales by 12%, exceeding the company's forecast.

As the pall cast by SARS over China fades, investors should return their focus to the country's growth potential. Jean-François Canton, managing director of Comgest Asia in Paris, is keen on Zhejiang Expressway, a toll-road operator in the Shanghai area. He says the company is a dual play on local economic expansion and growth in private car ownership. In South Korea, where the economy contracted 0.4% in the first quarter, the most attractive stocks are globally competitive blue chips. Samsung Electronics, the world's largest memory chipmaker, earned $5.9 billion on sales of $33.8 billion last year -- notably of wide-screen flat-panel TVs and mobile phones. "The safest bets are on players that outgun all their competitors," says Park Kyung Min, CEO of Hangaram Investment Management. He also likes Pohang Iron & Steel (PKX ) the world's largest and most profitable steelmaker.

Latin America has been the big surprise performer this year. Brazil's Bovespa index surged more than 50% in dollar terms in the first five months, thanks to Brazil's new President, Luiz Inácio Lula da Silva. Despite his background as a labor unionist, he has calmed financial markets by sticking to strict fiscal and monetary targets. That has helped bellwether oil company Petrobrás and Brazil Telecom (BRP ), two favorite stocks of Damian Fraser, chief Latin equities strategist for UBS in Mexico City. Fraser also likes beverage maker Companhia de Bebidas das Americas (ABV ), known as AmBev, which should benefit from stronger consumer spending by yearend as Lula's fiscal discipline is expected to usher in lower interest rates.

While no one can predict which direction the dollar will trade against the euro, peso, or yen, the best hedge against foreign currency risk is clear: a diverse portfolio of companies that are poised for growth in any climate.

By Frederik Balfour

With David Fairlamb in Frankfurt, Jason Bush in Moscow, Geri Smith in Mexico City, Brian Bremner in Tokyo, and Moon Ihlwan in Seoul

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