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NEW YORK — Forget an American-only 401(k). Investors are flocking to foreign funds and snapping up stocks from Europe, Asia and across the developing world.
The lure: Foreign stocks may finally be shaking out of their doldrums. After struggling for nearly a decade and falling well behind their U.S. counterparts, which raced to record heights, overseas stocks have been bouncing higher this year on expectations that economic and profit growth are on the upswing.
The most popular category of foreign stock funds has returned an average of 14.9% this year, through Wednesday, according to Morningstar. Funds that focus on stocks from China and other emerging markets have returned even more: 18.1 percent. Both easily top the less-than-10 percent return of a Standard & Poor’s 500 index fund of U.S. stocks over the same time.
Investors have noticed and are jumping onboard. They plugged $65 billion into world stock mutual funds and exchange-traded funds through the first four months of the year, according to the Investment Company Institute. That’s nearly triple what they put into U.S. stock funds and ETFs. The shift in sentiment has been so strong that investing in European and emerging markets has gone from being a contrarian move to a consensus one, BlackRock’s global chief investment strategist Richard Turnill wrote in a recent report.
For many investors, it’s an embrace of diversification. The thought is that having a portfolio filled with stocks from different economies makes it safer. When some areas of the world are struggling, others will hopefully be doing better and smoothing out returns. For the last several years, U.S. stocks have been the ones to plow ahead while others lagged. Perhaps the flip will be true in coming years.
At Harding Loevner’s Global Equity fund, managers had long been favoring U.S. stocks. For 10 years, it owned more U.S. stocks than its benchmark index held, and it was rewarded for it. The fund ranks in the top 9% of its category for 10-year returns.
But last year, it began cutting back on U.S. stocks after managers thought they had grown too expensive following their strong runs. By the end of the year, it was holding less in U.S. stocks than its benchmark index. Now it’s leaning more heavily on stocks from Europe, Japan and across the developing world.
“Things are going to change,” said Rick Schmidt, portfolio manager at Harding Loevner.
The U.S. recovery is further along than in Europe and elsewhere, which means those other areas may have more room still left to rise. “The banking system in the U.S. took its hits and recapitalized, and it was painful and expensive, and Europe didn’t do that,” Schmidt said. “Now, Europe is starting to.”
The fund hasn’t abandoned the United States – Google’s parent, Alphabet, is its biggest holding, and U.S. stocks still make up nearly half its portfolio. But it’s been more likely to trim its U.S. investments as their price tags continue to rise and use that cash instead in cheaper foreign stocks, such as Symrise, a German provider of flavors and fragrances.
Foreign stocks have long been cheaper than U.S. stocks, a result of their divergence in performance. Stocks across China and other emerging markets are trading at 12 times their expected earnings per share over the next 12 months, for example. Their U.S. counterparts are trading at a more expensive price-earnings ratio of nearly 18, according to MSCI indexes.
What’s different now is that analysts are expecting earnings growth for emerging markets to be stronger than for U.S. companies, said Patricia Ribeiro, portfolio manager at American Century’s Emerging Markets fund. “That’s positive, that’s the change,” she said.
The change has also brought in a wave of new investors, Ribeiro said, global funds that aren’t committed to emerging markets specifically. Such funds can be just as quick to leave as they are to enter, and an exodus at the next sign of trouble could exacerbate any price drops.
Emerging-market stocks, in particular, have a volatile history: The largest fund in the category, Vanguard’s Emerging Markets Stock Index fund, had a loss of nearly 53 percent in 2008, much deeper than the 37% loss for the S&P 500. Over the last four years, the fund has returned more than 1% just once.
Ribeiro, though, said she sees an exodus as less likely.
“If it were driven only by valuations, that may be the case,” she said. “What makes us more optimistic is the improving fundamentals: Earnings expectations are not only accelerating this year, but growth rates are higher than for developed markets. And when I’m meeting with company management teams, the tone is very positive in general.”