A World Of Opportunity Overseas -- But Keep An Eye On The Greenback

Foreign stocks have delighted American investors in 2003, and investment pros say there's more good news to come. Top companies from Paris to Tokyo are increasingly bullish about earnings as regional economies pick up momentum, a big change from the uncertain forecasts of a year ago. "The U.S. economy has performed quite well of late, but the really big surprise has been the performance of other economies," says Stuart Schweitzer, global markets strategist with J.P. Morgan Fleming Asset Management in New York.

So where are the best buys? Many stockpickers say to start in the Pacific Rim. Despite stellar gains -- from 57% in India to 89% in Thailand -- equities at most Asian bourses still look cheap compared with similar U.S. stocks. Price-earnings ratios based on 2004 profit estimates average about 12 times earnings in Asia, compared with 18 in the U.S. And speculation is rife that China may raise the value of its currency against the greenback, which would provide a nice fillip to returns on local stocks in dollar terms.

Beijing denies it has any plans to change its currency's peg to the dollar, but to make the most of any policy shift, experts say investors should have some exposure to pure China plays. A recent flurry of initial public offerings in New York and Hong Kong has made it easier for Americans to wade into Chinese equities. Consider China Life Insurance Co., whose Dec. 11 IPO raised a cool $3 billion, this year's biggest public offering. It's the No. 1 company in one of China's most promising sectors.

Trading partners

Another way to cash in on China's torrid growth -- with less risk -- is by betting on the trend toward tighter Asian economic integration. The Pacific Rim's fortunes are no longer tethered entirely to the American and European economies. For example, China is now the top export destination for both South Korea and Taiwan. And Japan imports more from China than it does from any other country. Intra-Asian trade has grown so much that it now accounts for 47% of the region's exports. This means Asia is less susceptible to slowdowns in the U.S. and Europe. "Asia is now Asia's biggest market," says Geoff Lewis, strategist at JF Asset Management in Hong Kong.

In fact, the Chinese are developing a reputation in Asia as major importers. China's demand for goods such as Japanese auto parts, South Korean machinery, and Taiwanese memory chips was expected to top $260 billion in 2003. Much of that is earmarked for equipping factories and assembling parts for re-export. But it's also in response to burgeoning domestic consumption. To get a piece of the action, Paul J. Hechmer, who manages the $30 million Nuveen NWQ International Value Fund for Chicago-based Nuveen Investments Inc. (JNC ), advises snapping up shares of Matsushita Electric Industrial Co. (MC ). The Osaka-based consumer-electronics giant makes and sells DVD players and flat-panel plasma TVs in China. He also likes Japanese cosmetic maker Shiseido Co., which sells high-end toiletries to China's expanding middle class. At the same time, chip foundries Taiwan Semiconductor Manufacturing Co. (TSM ) and United Microelectronics Corp. (UMC ) are favorites of JF's Lewis. Both are boosting shipments of chips used in PCs to China.

One advantage of investing in these Asian plays is that they profit from China's growth without the corporate-governance risks endemic at most mainland companies. In particular, partially state-owned Chinese companies are plagued by poor balance-sheet transparency and a lack of independent directors. "China is an incredible growth story," says J.P. Morgan Fleming's Schweitzer, "but one best played through [other Asian] beneficiaries of China's growth in the region."

Many Asian blue chips have teamed up with Chinese companies to combine outside management skills with cheap local labor. The strategy has worked for Japanese juggernauts Honda Motor Co. and Toyota Motor Corp., which are benefiting from China's growing appetite for both imported cars and locally produced models. Or, if investing in Japanese exporters seems an iffy proposition owing to the yen's 12% rise against the dollar in 2003, consider Chunghwa Telecom Co. Taiwan's largest phone company is mulling its first investment on the mainland, which could jump-start growth that it can't get in its saturated home market.

In the latest bout of dollar weakness, the biggest headache for American investors has been how to read the European markets. There, the question is how much more the euro will rally after strengthening 16% in 2003. While the euro's surge is a big negative for European exports to the U.S., hopes that the Continent is finally recovering are buoying investor sentiment. Stocks in the euro zone are trading at attractive valuations, with average p-e multiples of 14, notes Kevin Gardiner, head of European equity strategy at HSBC Holdings PLC in London. He suggests focusing on stocks that derive most of their revenue from home markets, because exporters' profits are starting to be hit by the weak dollar.

Among likely winners: France Télécom (FTE ), which has restructured its balance sheet by slashing a hefty debt load. Germany's Deutsche Bank (DB ) is also attractive to many investors because it could benefit from a revival in merger-and-acquisition activity on the Continent. Christian Stocker, an equity analyst at Munich-based bank HVB Group, likes the prospects for auto-maker BMW. Strong sales of the new 5 Series model will drive profit gains in 2004 as high as 19%, he says.

Off the beaten track

Looking for something off the beaten track? Try Kookmin Bank. Kang Shin Woo, chief investment officer at PCA Investment Trust Management Co. in Seoul, recommends shares of the South Korean lender, which are poised for a rebound now that a wave of consumer credit-card defaults that bedeviled it has crested and South Korea's economy is on an uptick.

Another promising diversification play is Indian outsourcing king Infosys Technologies Ltd. (INFY ), which profits handsomely from contracts with clients in the U.S. and Europe. "It's clearly a class act, with the highest margins in the Indian outsourcing it sector," says Ajay Kapur, Hong Kong head of Asia-Pacific Regional Strategy Research at Smith Barney (C ).

Tempting as foreign stocks may be, experts say all bets are off if the dollar rebounds sharply or Wall Street tanks. But the prospect for higher returns abroad may well be worth taking that risk. So consider putting international diversification on your list of New Year's resolutions.

By Frederik Balfour

With Moon Ihlwan in Seoul, Brian Bremner in Tokyo, David Fairlamb in Frankfurt, and Kerry Capell in London

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