Terrorists are ravaging Syria and Iraq, stoking fears of an
ever-wider conflict in the oil-rich Arab world. Vladimir Putin has
invaded Ukraine, threatening to ignite an economic war with Europe.
Eurozone economies are faltering and flirting with deflation.
Is this the time to buy foreign stocks? I think so. Here's why.
Sir John Templeton, a pioneer in investing overseas, once said to
buy "at the time of maximum pessimism." Templeton and a host of
others, including Warren Buffett, made their fortunes, in part, by
going against the crowd.
What's more, hard numbers back up the case for European and
other foreign stocks. Foreign stocks are cheap relative to U.S.
stocks--far cheaper than they deserve to be based on the admittedly
dismal fundamentals, says the Leuthold Group, a Minneapolis-based
investment research firm. Leuthold projects that foreign stocks
will return an average of two percentage points per year more than
U.S. stocks over the next seven to ten years. Leuthold predicts
that U.S. stocks will deliver returns only in mid single digits
over that span.
Consider price-earnings ratios based on analysts' earnings
estimates for the coming 12 months. The MSCI U.S. stock index (a
broad market index similar to Standard & Poor's 500) trades at
a P/E of 18--a little above its long-term average but hardly wildly
overpriced. The MSCI World Ex-U.S. index, which reflects developed
markets outside the U.S., trades at 15 times estimated earnings,
15% less than the U.S. market's P/E.
The biggest bargains of all are in emerging markets. The MSCI
Emerging Markets index trades at a P/E of just 12--one-third
cheaper than U.S. stocks. Of course, emerging markets face many
problems, including government ownership of portions of many
companies, but markets with a P/E of 12 are hard to pass up.
Truth be told, Leuthold doesn't think forward P/E ratios are
particularly helpful in projecting future stock prices, mainly
because analysts tend to be over-optimistic with their profit
projections. Doug Ramsey, chief investment officer at Leuthold,
says "normalized" P/Es often do accurately foretell stock prices.
To normalize earnings (the E in P/E) so they're not distorted by
the ups and downs of the economic cycle, Leuthold averages five
years' worth of earnings.
By this measure, U.S. stocks are pricey. The MSCI U.S. stock
index trades at a P/E of 23. The MSCI ex-U.S. index trades at a P/E
of 19--not low, but low compared with the U.S. And the MSCI
Emerging Markets index boasts a P/E of just 14.
Ramsey says the reality is probably even more favorable for
foreign stocks than the numbers indicate. U.S. corporate profit
margins are at record highs. Margins are more likely to fall rather
than rise, making it more difficult for companies to boost
earnings. Moreover, the U.S. is later in the economic cycle than
most of the rest of the developed world. Earnings in most foreign
countries, Ramsey says, haven't recovered as fast as U.S. earnings
since the great recession.
What to do? Leuthold's global allocation model recommends 55% in
foreign stocks. Ramsey says a U.S.-based individual investor should
put 30% to 35% in foreign stocks, with about one-quarter of that in
emerging markets. I think those are sensible allocations. Says
Ramsey: "Regardless of your opinion on Europe, the bad news is
already in the price. Consequently, we should see excess returns in
Below are my four favorite no-load foreign stock funds.
Dodge & Cox International Stock (
) has offered a somewhat bumpy but ultimately profitable ride. Over
the past ten years, it returned an annualized 9.8%--an average of
nearly two percentage points per year better than the MSCI World
All-World ex-U.S. index. The fund, a member of the Kiplinger 25, is
slightly more volatile than the index and currently has almost 20%
of its assets in emerging markets. Dodge & Cox is a value shop,
meaning its managers tend to favor stocks that are cheap in
relation to a company's earnings and other key measures. And the
managers are patient: They typically hold stocks for long periods
and tend to stay at the firm for their entire careers. Annual
expenses are 0.64%. (All returns are through September 3.)
Harbor International (
) lost a brilliant manager when Hakan Castegren, who launched the
fund in 1987, died in 2010. But he spent years tutoring the fund's
three comanagers in his discipline. Over the past three years, the
fund bested the MSCI index. And over the past ten years, it
returned an annualized 9.5%. Like Dodge & Cox, the fund is
slightly more volatile than its benchmark, but, in contrast to
Dodge & Cox, Harbor favors companies with fast-growing earnings
and tends to shun emerging markets. Expenses are 1.11%
Harding Loevner Emerging Markets (
) has produced superior returns with less volatility than the MSCI
Emerging Markets index. Over the past ten years, it gained an
annualized 12.8%--an average of 0.3 percentage point per year
better than the index. The fund's veteran managers favor
high-quality companies. The fund currently has 10% stakes in both
Brazil and India, overweights compared with the index. Expenses are
1.47% a year. The fund is a member of the Kiplinger 25.
Vanguard Total International Stock ETF (
) is a solid pick if you're looking for an index fund. For an
annual cost of 0.14%, this exchange-traded fund gives you the
entire world outside the U.S., including a 19% stake in
emerging-markets stocks. The fund tracks the FTSE Global All Cap
ex-U.S. index, which includes Canada, a country that many
developed-world benchmarks inexplicably exclude. If you have
$10,000, you can buy Vanguard Total International Stock Index
), a mutual fund version of the same product.
Steven T. Goldberg
is an investment adviser in the Washington, D.C. area.