It seems so obvious.
Smart investing means looking for bargains and buying the type of stocks and stock funds that are cheaper than others. On that basis, you might assume that buying a foreign fund now would be just the bargain you should seek.
But hold on. Foreign funds are not at bargain-basement prices.
It’s true that the global economy has been struggling. Europe has been on the edge of recession for months, with unemployment in places such as Spain at about 24 percent.
But that doesn’t mean foreign funds are a screaming deal. Stocks have been climbing in price even though many economies outside the U.S. remain troubled. And for Americans, who use dollars to invest in foreign funds, the deals have evaporated even faster than for foreign investors. Foreign stocks, on average, are even pricier in dollars than they were just before the financial crisis that began showing up in 2007.
Morningstar analyst Kevin McDevitt notes that the Morgan Stanley Capital International All Country World Index, excluding the United States, makes the point. That index represents the value of foreign stocks outside the U.S. And the price on it recently was 16.4 times the profits the companies within the index have earned during the past 12 months. The price is actually higher than May 2007, when the price of the index was 15.7 times its earnings.
That means Americans are spending more to invest in the world now than they were when the globe was on a sugar-high of borrowed money just before the financial crisis.
If people pick foreign funds now, they will get a price somewhat better than if they invested exclusively in the U.S. The price of the large U.S. stocks that make up the Standard & Poor’s 500 Index is about 19.5 times the profits those companies earned the past 12 months.
“I don’t think anyone sees a corner of the world that’s very cheap. This is a very difficult environment in which to invest,” McDevitt said.
Savvy investors search for deals because a cheap stock or area of the globe can climb a lot when conditions in the economy or profits improve. Yet, a pricey stock or stock fund may not climb much after purchased, because people paid a pretty penny for it in the first place based on great expectations. And if a sudden shock in the economy or in profits hits, investors who paid a lot for investments, can get scared quickly and dump it as they run for safety. The result: The stock or stock fund can plunge hard.
Although investors might think European or Japanese stock funds must be a bargain now after lengthy troubles in those economies, investors have been rushing to buy them for months. So deals have already eroded. Japan’s stock market is near a 15-year high, and Germany and France have been near all-time highs.
Stocks are being driven up in price by actions taken to stimulate troubled economies in Japan and Europe. Central banks there have been buying bonds to push interest rates on savings accounts and safe bonds to very low levels. Consequently, investors have a lot of money to invest, but don’t want to earn near zero interest rates in safe bonds. So they’ve decided to take greater risks in stocks. And as they’ve bought more stocks, that’s pushed prices higher; ending bargains.
For Americans, bargains have been sharply reduced, McDevitt said. When an American invests money in a foreign fund, 401(k), IRA or other account, they use their dollars. And that makes a big difference for the outcome and also the value of the investments to Americans.
Take the MSCI Europe Index, which shows how much people would make on average in the European stock market. If you simply focused on how the European stocks performed in euros during the past 12 months, an investor would have made 18.5 percent in the European companies, a delightful return. But Americans wouldn’t get that because they don’t invest euros. Rather, U.S. dollars would be much stronger than euros. And as a result, European stocks for Americans have ended up as losers.
Over the past 12 months, instead of making 18.5 percent in the MSCI Europe Index, an American would have lost 0.8 percent in dollars, notes McDevitt. Foreign markets have become less valuable to Americans as the dollar index has climbed about 22 percent.
That doesn’t necessarily make foreign funds a bad investment. For the sake of diversification, keeping foreign and U.S. stocks makes sense. But if the goal is bargain-hunting, foreign funds don’t make the grade.
Gail MarksJarvis is a personal finance columnist for the Chicago Tribune and author of “Saving for Retirement Without Living Like a Pauper or Winning the Lottery.”