Heavy overseas stock exposure has risks
NEW YORK (AP) — In today’s financial world, there’s nowhere to hide from each other’s economic woes.
For investors smitten by the global economic story, that’s something to remember. As evidence mounts that the U.S. housing and mortgage collapse isn’t just a local problem, they can’t expect the economies of other nations to keep chugging along without any effect.
In recent days, foreign markets have slumped along with U.S. stocks on economic concerns, and the International Monetary Fund just lowered its global growth forecast for 2008 to 4.8 percent, cutting nearly a half a percentage point from its July forecast. All of that calls into question the “decoupling” strategy. That’s where some investors bet they will get big returns by moving money into stocks with a large international presence to participate in the faster-growing global economy.
There have been rewards of going that route. For the first nine months of this year, shares of Standard & Poor’s 500 companies deriving at least a third of their sales outside the United States saw a return of nearly 15 percent, on an equal-weighted basis. That’s well ahead of the nearly 6 percent gain in the equal-weighted S&P 500 index over the same time, according to Citigroup.
But some cracks are starting to form in that strategy. In recent days, having a large international exposure hasn’t helped some companies — notably Caterpillar, 3M and Honeywell — salvage their earnings from U.S. troubles.
It is also becoming increasingly clear that the credit crunch is spreading beyond U.S. shores. Just a few months ago it seemed as though the surging default rates in mortgages to those with shaky credit, known as subprime loans, would mostly hurt the U.S. economy. Now, that theory has begun to unravel.
Beginning in August, the subprime meltdown set off what has turned into a full-fledged global credit crisis as lending standards have tightened all around. Central banks have been forced to infuse the financial system with liquidity, and many have decided to not raise interest rates due to weak credit conditions.
For instance, the spreads on funding costs in London and in the Euro zone over policy rates remain at 10 to 20 basis points wider than they were before the August shock. That means bank lending rates are steeper than they were just a few months ago and households and businesses are finding credit harder to secure, according to Morgan Stanley economist Richard Berner.
The spending habits of American consumers also threaten the “decoupling” strategy. Shoppers haven’t yet gone on a buying strike, but should they begin to curb their spending, that would hurt foreign growth considerably by lowering demand for U.S.-bound exports.
Given the mounting financial turbulence around the world, the IMF revised its economic forecast last week to reflect these uncertain times. “Risks to the outlook lie firmly on the downside, centering around the concern that financial market strains could continue and trigger a more pronounced global slowdown,” according to its World Economic Outlook Update.
The IMF is now forecasting 1.9 percent growth in 2008 for the U.S., down from a 2.8 percent estimate in July. It also cut its 2008 forecast for China by 0.5 percentage point to 10 percent and sliced its estimate for European Union countries by 0.4 percentage point to 2.1 percent.
Yet even with all this going on, there’s still plenty of interest in internationally focused investments. Citigroup’s chief U.S. equity strategist Tobias Levkovich notes that there are increased volumes of requests for overseas sales exposure, which “suggests that everyone is looking in the same place for outperformance opportunity.”
That herd mentality is troublesome if investors don’t recognize the risks. Levkovich likens it to the wave of stock-buying interest earlier this year in potential buyout candidates, whose shares rose sharply until the private-equity boom became a casualty of the credit crisis over the summer.
A look back in history shows how the international investing theme can backfire. At the start of this decade, many investors argued that the U.S. economic slowdown wasn’t going to affect European economies that were thought to have little exposure to U.S. exports. But then the technology boom went bust, and Asia — like the United States — was rocked hard by the downturn. Europe took a hit, too, because it exported into other parts of the world that were affected, Levkovich said.
That’s why investors can’t just throw cash overseas and count on happy returns. The world is connected in ways that might not even be obvious.
Rachel Beck is the national business columnist for The Associated Press. Write to her at rbeck(at)ap.org
Published in The Messeneger 10.24.07