Market Globalization and the Allure of Foreign Stocks
by
Charles Lamson
In addition to all the different types of stocks mentioned above, a growing number of American investors are turning to foreign markets as a way to earn attractive returns. Such securities became increasingly popular during the 1980s and 1990s, and many investment advisors today recommend that investors put at least part of their capital into foreign stocks. A good deal of this interest has come about as advances in technology and communications, together with the gradual elimination of political and regulatory barriers, have allowed investors to make cross-border securities transactions with relative ease. Because of these changes, not only are more and more Americans beginning to invest in foreign securities, but foreign investors are becoming major players in U.S. markets as well. The net result is a rapidly growing trend toward market globalization, whereby investing is practiced on an international scale rather than confined to a single (domestic) market.
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Ironically, as our world is becoming smaller, our universe of investment opportunities is growing by leaps and bounds. Consider, for example, that in 1970 the U.S. stock market accounted for fully two-thirds of the world market. In essence, our stock market was twice as big as all the rest of the world's stock markets combined. That is no longer true, for in 2002 the U.S. share of the world equity market had dropped to less than 50 percent. Today, the world equity markets are dominated by just six countries, which together account for about 80 percent of the total market. The United States, by far, has the biggest equity market, which in mid-2003 had a total market value of around $10 trillion. In a distant second place was Japan (at about one-third the size of the U.S. market), closely followed by the United Kingdom. Rounding out the list was Germany, France, and Canada.
In addition to these six, another dozen or so markets, such as Switzerland, Australia, Italy, Singapore, and Hong Kong, are also regarded as major world players---not to mention a number of relatively small, emerging markets, such as Mexico, South Korea, Thailand, and Russia. Thus, investors who continue all their investing to the U.S. markets are missing out on a big chunk of the worldwide investment opportunities. Not only that, they are missing out on some very attractive returns as well. Over the 23-year period from 1980 through 2002, the U.S. stock market provided the highest annual return just once in 1982. And that statistic pertains to just the 8 largest (major) markets of the world---it does not include the smaller (emerging) markets that, in recent years, have provided some spectacular returns. Of course, it also ignores some spectacular crashes that have occurred recently in these same emerging markets.
So if you are looking for better returns, you might want to give some thought to investing in foreign stocks. There are several different ways of doing that. Without a doubt, from the perspective of an individual investor, the best and easiest way is through international mutual funds. Mutual funds aside, you could, of course, buy securities directly in the foreign markets. Investing directly is not for the uninitiated, however. For although most major U.S. brokerage houses are set up to accommodate investors interested in buying foreign shares, many logistical problems still have to be faced. Fortunately, there is an easier way, and that is to buy foreign securities that are denominated in dollars and traded directly on U.S. exchanges. One such investment vehicle is the American Depository Receipt (ADR). ADRs are just like common stock, except that each ADR represents a specific number of shares in a specific foreign company. Indeed, the shares of more than 1,000 companies from some 50 foreign countries are traded on U.S. exchanges as ADRs, companies like Sony, Ericsson Telephone, Nokia, Vadafone Airtouch, Shanghai Petro-chemicals, and Grupo Televisa, to mention just a few. ADRs are a great way to invest in foreign stocks because they are bought and sold, on American markets, just like stocks in U.S. companies---and their prices are quoted in dollars, not British pounds, Swiss franks, or Euros. Furthermore, all dividends are paid in dollars.
Whereas the temptation to go after higher returns may be compelling, keep one thing in mind when investing in foreign stocks---that is, whether investing in foreign securities directly or through something like ADRs, the whole process of investing involves a lot more risk. That is because the behavior of foreign currency exchange rates plays a vital role in defining returns to U.S. investors. As the U.S. dollar becomes weaker (or stronger) relative to the currency in which the foreign security is denominated, the returns to U.S. investors, from investing in foreign securities will increase (or decrease) accordingly. Currency exchange rates can, in fact, have a dramatic impact on investor returns and quite often can convert mediocre returns, or even losses, into very attractive returns---and vice versa. only one thing really determines whether the impact is going to be positive or negative, and that is the behavior of the U.S. dollar relative to the currency in which the foreign security is denominated. In effect, a stronger dollar has a negative impact on total returns to U.S. investors, and a weaker dollar has a positive impact. Thus, other things being equal, the best time to be in foreign securities is when the dollar is falling, because that increases returns to U.S. investors.
*SOURCE: PERSONAL FINANCIAL PLANNING, 10TH ED., 2005, LAWRENCE J. GITMAN, MICHAEL D. JOEHNK, PGS. 515-517*
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