Don't give up on international stocks

Nation's Business, March, 1998 by Randy Myers

For much of this decade, experts have told us we can pump up our investment returns with international stocks.

Many of us listened, pouring money into exotic locales from Milan to Malaysia. Assets in international mutual funds grew to $210.1 billion by the end of November 1997, up from $9.9 billion at the start of 1990, according to the Investment Company Institute, a fund trade group based in Washington, D.C.

But late last year and early this year, Southeast Asian financial markets began a meltdown as the region's economies were overcome by excessive borrowing. Not surprisingly, many investors began to question their faith in international investing.

The average international equity fund fell 7.7 percent in the fourth quarter of 1997, while the average Pacific-region fund, excluding Japan, fell a wrenching 28.6 percent. Faced with numbers like that, it takes enormous confidence to send money overseas now, especially when the U.S. economy model of productivity.

Nonetheless, it probably doesn't make sense to give up on overseas investing. It is when events look most bleak, after all, that bargains are likely to be found.

In the mid-1980s, many pundits were convinced that Japan was on a sure route to world economic leadership while the United States, hamstrung by declining Rust Belt industries and a huge federal budget deficit, was on its way down. Events have proved just the opposite, and the United States, not Japan, has enjoyed record-beating stock-market returns during the 1990s.

That said, it would be rash to assume that foreign stocks are a good value just because they're cheap. Japan's Nikkei 225 stock index peaked at just under 39,000 on Dec. 29, 1989, and has spiraled ever lower in the eight years since, finishing last year just over 15,000. Anybody who bought into the Japanese market at 30,000 -- or 25,000, or 20,000 -- has been sorely disappointed.

Leila Heckman, managing director of research on global asset allocation for Salomon Smith Barney Inc., a Wall Street investment bank, provides this dispassionate view of international stock markets, particularly those in Southeast Asia: "Nobody has a perfect crystal ball, but if you look at Asian stocks by traditional measures, such as their price-to-book-value and their price-to-earnings ratios, many do look attractive right now

"In what we call emerging Asia [China, India, Indonesia, Malaysia, Pakistan, the Philippines, South Korea, Taiwan, and Thailand], stock prices are just 1.7 times their book value, versus an average price-to-book ratio of 2.2 for all world markets. So these stocks are cheaper than the rest of the world."

(In December 1993, the price-to-book ratio for emerging Asia was extraordinarily pricey at 4.4.)

Similarly, stocks in emerging Asia are trading at much lower multiples of their forecasted earnings -- about eight or nine times 1998 estimates -- than are world markets overall, where the average price-to-earnings ratio is 13. So again, the Asian markets look cheap.

The problem with that analysis, however, is that nobody knows for sure how reliable Wall Street's forecasted earnings numbers will be, Heckman says. "The forecasted earnings for 1998 are still coming down. I think these price-to-earnings ratios are overly optimistic."

Gary Motyl agrees. "A lot of companies in these countries haven't come forward with detailed disclosures" of their condition, says Motyl, manager of the Templeton Capital Accumulator Fund, which invests in stocks around the globe. "We're working with stale data in many cases."

On the other hand, Motyl says that while a large number of companies will certainly be hurt by the economic turmoil in Southeast Asia, some will just as certainly survive. "We saw this pattern most recently in Mexico," which had its own financial crisis in 1994, Motyl says. "The survivors can then take real advantage of the stable economic situation [that follows] and prosper."

Many economists believe that Southeast Asia can recover fairly quickly -- much faster than Japan -- if the countries there adopt the tough economic reforms being pushed by the International Monetary Fund. While Japan's wealth and the size of its economy have allowed it to survive while putting its financial problems on the back burner, some other Asian countries won't have that luxury, the reasoning goes.

The upshot, in Motyl's view, is that investors should continue to hold a portfolio of stocks diversified by region and country. "What we've seen in the last few months illustrates the value of that strategy," he says. "Obviously, if you had a portfolio concentrated in Asian markets, you would have been hurt rather badly. But had you been diversified across other emerging markets, such as Latin America and Eastern Europe, you would not have suffered large double-digit losses."

For investors who do see opportunities in Asia, Heckman suggests a cautious strategy of buying in small quantities over the course of the year rather than plopping down a big wad of cash right now. "The investor hoping to reap a profit in Asia in six months might be disappointed -- or pleasantly surprised," Heckman says. "But those with a two-to-three-year time horizon could do very well."