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Foreign Funds Up 4% In Q1: Five Countries To Buy Now

By: Investor's Business Daily
Posted: 4/2/2013 6:19:00 PM
Referenced Stocks: EFA;FXY

Foreign mutual funds lagged their U.S. peers this year as the Cyprus bailout and fears of slower growth in China roiled global markets.

The average world equity fund added 0.88% in March and 3.86% the first three months of the year as Japan's outperformance offset losses in Europe and emerging markets. Japan funds soared 6.15% in March and 12.75% year to date as a weak yen juiced exports.

CurrencyShares Japanese Yen Trust ( FXY ), measuring the yen against the dollar, tumbled 7.94% in Q1. The island nation's new central bank governor Haruhiko Kuroda pledged to do everything possible to get the economy out of deflation. Japan's consumer confidence in February reached its highest level since the 2008 financial crisis.

It appears stocks have started to price in an economic recovery taking hold next year. Credit Suisse sees inflation rising 0.5% this year and 2.2% next year while industrial production grows 1.8% this year and 3.7% next year.

Europe stock funds were flat in March while adding 2.91% year to date. European stocks sold off heavily the last week of March on fears the Cyprus bank bailout would be used as a template for future bailouts. The region will likely stay in a recession this year with gross domestic product shrinking 0.5% year over year, according to S&P Capital IQ.

Credit Suisse analysts increased their underweight rating for Continental Europe in global portfolios, in a report released March 27. Valuations, currently 12.4 times forward earnings, are slightly above its historical average and appear expensive given projected real earnings growth of 3% at most this year.

"Moreover, the strength of the euro that we expect will further hit earnings given that 57% of earnings come from outside Europe," Credit Suisse analysts wrote. They expect the euro, currently trading at $1.28, will rise to $1.40 over 12 months.

Appetites for Continental European equities remain high relative to other markets. The cost of bank funding has increased since the Cyprus bailout the last week of March. Demand for and supply of corporate loans are weakening.

The private sectors in Spain, Ireland and Portugal still have too much debt on their hands and loan repayments have been small relative to the fallouts of previous banking crises.

The Continent's most debt-ridden countries sold off heavily in March on fears the Cyprus bailout could be used as a blueprint for future bailouts. The MSCI Greece Index lost nearly 5% in March, paring its year-to-date return to 12%.

Italy's Decline

Italy's stock market, the region's worst-performing country this year, fell 5.6% in March, bringing the year-to-date decline to 10%. Spain dropped 6.5% in March and 7% year to date.

Emerging market funds lost 1.04% in March and were nearly flat year to date. The FTSE Emerging Markets index currently trades at about 11 times forward earnings, a discount to iShares MSCI EAFE Index ( EFA ), tracking developed foreign markets, which trades at 13 times forward earnings.

"Historically, investing in emerging markets at inexpensive valuation multiples has tended to be rewarding," Leila Heckman, managing director and senior portfolio manager at Roosevelt Investment Group in New York, wrote in client note. "Since 1989, emerging market equities have traded between 6.8 times and 22.3 times forecasted earnings, with an average multiple of 12.5 times."

Top Five Countries To Invest In

Geoffrey Pazzanese, co-manager of Federated InterContinental with $639 million in assets, is placing his bets on Germany, Norway, South Korea, Brazil and Mexico. All of these markets have been weak this year, except for Mexico, which gained 5.6%.

Germany is trading at cheap valuations yet is full of high-quality multinational companies poised to take advantage of global growth, Pazzanese said.

Norway is a big oil services play. Korea won the tech war against Japan and Taiwan. Yet it's trading at cheap valuations of 8.6 times earnings and 1.2 times book value with expectations of 20% earnings growth over the next 12 months.

Brazil is trading at 1.1 times book value with projections for 20% to 25% earnings growth. Its central bank has cut interest rates from a 12.5% to 7.25% over the past two years to spur economic growth. It also stands to benefit from a massive infrastructure buildout to prepare for the World Cup in 2014 and the Olympics in 2016.

Mexico carries a low level of government debt to gross domestic product and a low trade deficit while being heavy on foreign cash reserves.