Monday, April 09, 2007

Foreign Stocks & India

Perceptions of Foreign Markets

America's stock market is so large and liquid that for years you could just invest in US based stocks with only a smattering of foreign issues and get a broad coverage and a good return. Foreign markets were viewed as less credible in terms of financial regulations and they panicked when economic growth soured.

Another issue is foreign currency risk. When you buy a foreign stock, you not only get whether or not it will go up or down, but the fact that the local currency moves independent of the dollar acts as a sort of leverage. For example, when the dollar goes down against the yen, Japanese stocks have a better return for US investors. If the dollar appreciates against foreign currencies, the opposite occurs.

Finally, you have the fact that it wasn't easy to buy foreign stocks. Many of these overseas markets have rules and regulations and you can't just call your broker or go online and make a simple purchase or sale.

The performance of foreign stock markets has been variable. Japan is a case in point; in 1989, at the peak of their valuation, the Nikkei 225 index in Japan peaked at 39,000; it fell down to below 10,000 before moving up to 17,500 today (in 18 years it has only recovered 1/2 its value!). You could compare this with the disastrous swoon of the US NASDAQ market which peaked at 4700 and went down to below 900 at its nadir after the 2000 crash; the difference is that NASDAQ was mainly technology stocks while the Nikkei was a broader index similar to the S&P 500.

Thus you could sum up the case against foreign markets (and focus on US markets as):
  1. less credible regulation
  2. foreign currency risk
  3. difficulty of buying stocks
  4. erratic market performance
The Future of Foreign Markets

From a US investor perspective, it now makes a lot more sense to look at foreign markets. In the longer term, as the economies of China, India and other nations like Russia grow larger, it will be more and more difficult to ignore these nations. Growth is a big driver of stock prices and much of the growth will be in these overseas markets; this does not mean that you should dive in blindly, but it means that you shouldn't ignore it, either.

The US market scandals with Enron, WorldCom and others showed that US regulation had a lot of holes; this doesn't mean that foreign regulations were necessarily any better but the perceived benefits of US style regulation were not as much an advantage as it has been in the past. The US and foreign markets are moving closer on harmonizing on international accounting standards; while there are still significant gaps, the differences are closing.

The foreign currency risk is always there and cannot be wished away unless you want to hedge, which is beyond the scope of this post. You could also look at it not as a risk but as an opportunity; everyone in the US is essentially investing in the dollar, and it could be a good thing to also have Euro-based and yen-based assets. This element is complex and more so by the fact that many US based companies have strong overseas subsidiaries and thus already have significant foreign currency exposure.

The difficulty of buying foreign stocks is still there but it is getting easier. All along there have been "ADR's" or foreign stock that you can purchase through a US based exchange such as the NYSE. There are more and more ADR's every day, for major companies like Toyota (Japan), China Mobile (China), Broken Hill Proprietary (Australia), and too many others to list. Many new ETF's also offer opportunities to purchase foreign stock indexes, as well as many mutual funds. Brokerage tools such as eTrade and those offered through Fidelity are also adding more and more foreign stocks; it seems likely that in the future the big companies will work out how to make it possible to buy and sell the major stocks (with liquidity) almost as easily as you could buy US stocks. London is also becoming the home for many issues that would otherwise be difficult to trade in their host country; for example many of the huge energy companies out of Russia now trade on the LSE, so if you can trade the LSE, you have access to these stocks, as well (much easier than trying to trade on the Russian exchange).

Erratic market performance is always there, as well as the shorter time frame of historical data on these exchanges. The US and Britain are lucky in that we weren't taken over by war or ideology and have long track records for our exchanges; obviously France, Germany, Japan, India and Russia have major gaps, and China is just getting started. However, many of these markets are now long since established and contain many powerful and growing companies.

India:

I run some portfolios for others and recently looked at some Indian stocks. India is fast growing, a democracy, with many highly motivated and educated workers. While they have other problems in that country, they certainly are a huge growth story and one that every US investor should at least start to watch.

I looked at a few ADR's because I wanted to be able to buy individual stocks on US exchanges; I am certain that at some point in the future you'd be able to buy directly on their exchange but that is a long way away for me, since I am just dipping my toes in the water.

A couple of ones that are star performers are ICICI Bank (NYSE: IBN) and TATA Motors (TTM). Probably a better way to get into India in the longer term is a mutual fund or ETF that covers a market index, of which there are too many to mention.

Conclusion:

Like everything else on this blog, it is just an educational tool. The key point here is that US investors need to start learning about foreign markets since that is where a huge chunk of the worldwide growth will occur. In the past the US market has been so big and liquid that you could essentially get away without knowing much about world markets and still do fine on your portfolio. I don't think that will be the case in the future.

1 comment:

Dan from Madison said...

Good post. In addition, most money managers that specialize in a "basket" of foreign company stocks usually have feet on the ground all the time at those companies. Due to the volatility you mentioned, it is even more important that fund managers get reliable information from foreign companies, especially in emerging markets.

Any diverse portfolio IMHO should have 5-10% international exposure of some sort.