Stocks: Think Globally
The Group of Seven leading industrial nations generated a lot of headlines over the past week, after the international organization urged emerging-market countries with large current account surpluses not to restrain appreciation in their currencies.
G-7, which is made up of finance ministers from Japan, Germany, the United Kingdom, Italy, Canada, France, and the United States, singled out China, which many policymakers in the U.S. argue has kept its exports artificially cheap by strictly controlling its currency. A weaker currency tends to bolster exports by making their prices more attractive in foreign export markets.
Since Asian economies are heavily dependent on exports, currency appreciation is perceived as a negative for overall economic growth and exporter earnings. Thus, the G-7 call depressed stocks around the region as Asian currencies rallied against the U.S. dollar in response to the statement. Selling was widespread and included stock markets in Japan, Taiwan, South Korea, Hong Kong, and Indonesia.
S&P Equity Strategy believes these concerns are overblown, because our analysis indicates that robust global growth will more than offset the negative effect of modest currency appreciation on Asian exports and corporate profits. It does not surprise us that, despite G-7-related selling, the S&P Asia 50 index was still up 12%, in U.S. dollars, this year through April 24.
In addition, we think it is important for U.S. investors to remember that a weaker dollar increases the value of their foreign investments.
This year through April 24, the dollar has fallen 4.9% against the euro and 2.8% against the yen. Standard & Poor's forecasts that the dollar will fall 10% against the euro and 7% against the yen by the end of 2006. European and Japanese stocks represent roughly 80% of equity market capitalization outside the U.S.
In Europe and Japan, our bullishness on the euro and yen is based largely on the wide interest rate differentials (which benefited the greenback last year) that are beginning to narrow as an end to U.S. rate hikes appears on the horizon. S&P Economics anticipates a May peak in the fed funds rate. We believe that, coupled with measured tightening by the European Central Bank (ECB) and the Bank of Japan (BOJ), an end to Fed rate hikes should render the euro and yen more attractive to global investors, as interest rate spreads shrink. S&P expects dollar weakness to accelerate in the second half of 2006, when we anticipate that ECB and BOJ tightening will have progressed further, giving capital markets more confidence in the central banks' tightening intentions.
We believe the dollar's fall validates the S&P Investment Policy Committee's recommendation of a 20% asset allocation to foreign stocks. The benchmark against which our allocation is measured calls for a 15% allocation to foreign issues, but we think a significant overweight position has been paying off -- and will continue to pay off -- for investors.
For example, the S&P Euro 350 index is up 13.8% in U.S. dollars so far this year. Without the currency conversion, that index has a gain of only about 9%. Similarly, the S&P Topix 150 index, a measure of Japanese stock market strength, is up 9.8% in U.S. dollars, but up only 7% without the currency conversion. We continue to support our overweight recommendation for foreign equities.
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