For many decades investors from foreign countries, such as England, have been comfortable putting money into other nations’ stocks. But it is only been the last 25 years American investors have become interested in investing in foreign markets. Not that unusual, by the time that many U.S. investors get comfortable investing in a foreign market, the market has been making headlines for quite sometime and is often near the end of a long run to the upside. Thus, a fair number of foreign markets like Japan in the early 1990s, Russia, Southeast Asia and South America in the later 1990s, left many with a bad taste in their mouths as these crated after a big run up. The Japanese Nikkei Index in particular, topped out in early 1990, above 40,000. It is still nearly three quarters of the way down from those highs, trading at approximately 9,500.
Buying international stocks, like any stocks, can produce great returns. In the best of all possible worlds, investors can win three ways. First, the stock rises in price, providing capital gains. Secondly, the investment pays dividends. Thirdly, the country’s currency rises against the dollar so that when an investor sells they get more dollars.
However, investing in foreign stocks is just as risky as investing in stocks at home. The fact is, the investment can really go against you because of the currency side of the trade. In addition, there is no question that stock prices do fall and that dividends get cut. That is exactly what happened in the late 1990s to many of the “emerging market” (countries where there is a rapid increase in industrialization and economic growth) stock markets.
There are some additional risks. The tax treatment of gains or losses differ from one country to another. Accounting and trading rules may be different. Converting dividends into dollars may add extra expenses to the transaction. Some international exchanges require less information about a company’s financial condition than U.S. exchanges do. Giving buy and sell orders can be complicated by distance and language barriers. Finally, unexpected changes in overseas interest rates can cause major currency upheavals.
Developing countries can have very good growth opportunities. However, they also can have weak institutions such as little or no rule of law, lack of financial regulation, there are often banks loaded up with non-performing loans and other problems. Many investors go into these markets with high expectations of solid returns but often with a good deal of misunderstanding of the real problems. As a result, prices are bid up to unrealistic levels in good times and often followed by financial crisis and institutional collapse.
There are numerous ways for an American investor to buy international stocks. You can use an international U.S. brokerage firm with foreign branch offices. Some international and multinational companies are listed directly on U.S. exchanges and are sold as American depositary receipts on U.S. exchanges, although currency changes can affect these holdings. Many mutual fund companies offer international funds that invest in the stock of some of the largest foreign companies.
The bottom line, international investing has many of the same pros and cons associated with domestic markets. All markets, yes, all markets are subject to cyclical and longer-term secular declines, which can be severe. Taking advantage of them, takes every bit of discipline as does taking advantage of domestic markets. The problem is that the average investor doesn’t get involved in them unless they have become popular by going up for a long time and things look great — just about the time when they have run their course to the upside. This is the same problem that exists in the domestic market.
Quote of the week: “In the course of evolution and a higher civilization we might be able to get along comfortably without Congress, but without Wall Street never.” — Henry Clews, 1900
Bart Ward is the chief executive officer of Ward & Co. Ltd., an Anoka-based registered investment adviser – specializing in the management of stock and bond portfolios in companies which are listed on the NYSE.