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|No doubt about it: Investors are concerned about the state of the US economy. The financial markets are looking bleak and the possibility of a recession is becoming a reality. This decline is making US equities less attractive investments, at least for the near future. So what's an investor to do? You might want to consider diversifying your portfolio by investing a portion of it overseas. |
When it comes to investing outside the United States, the most important investment decisions are which countries and when. All economies go through business cycles, and it is to your advantage to time the cycle and choose the best periods to either hold or "not hold" investments. Each country is in a different economic cycle, which means that while the US economy falls, others may rise. The challenge lies in determining which countries will rise while the US falls.
With that in mind, given the vast array of countries to choose from, you have a rather difficult task. In addition, you need to understand the interrelation of several economic variables and access the necessary data. Unfortunately, the only objective indicators available are macroeconomic statistics. These can be found on several sites on the Internet as well as from the World Bank and International Monetary Fund (IMF). But how do you decide which of these statistics are the most valuable? Is it total gross domestic product, better known as GDP (a measure of the overall economic activity of a country)? Is it inflation? Is it economic growth, central bank reserves, or some combination of the more than 751 variables defined by the IMF?
Peaks and troughs and periods of expansion and contraction are
WHAT SHOULD YOU LOOK FOR?
Fortunately, only a few variables are significant in determining the performance of an economy. Conditions can change, but I have found that the strongest indicators for determining the overall profitability for the near-term future (one year) are:
Interest rate shifts can have drastic effects on a nation's economy. These movements are influenced by several factors, including the state of the economy, inflation, monetary and fiscal policies, and political conditions. The combination of all these factors establishes the trend or direction of the interest rate.
Interest rates are fixed by the central banks and kept in line with the banks' objectives of a growing economy and low inflation. High interest rates mean individuals and businesses will be less inclined to borrow. Less borrowing means less growth, which will have a negative effect on the economy. There are some benefits to higher interest rates, though. Increasing interest rates create attractive returns on investments in Treasuries. If interest rates increase, it implies that the economy is overheated and corporate profits are high, making stock market returns more assured. For example, this was evident in the past two years in the US stock market, where a meteoric rise coincided with rising interest rates and the end of the economic cycle.
All countries depend on other countries for exports and imports, which is why trade links among nations are significant in determining the health of a nation. Because of this, the trade balance of goods and services - the total value of exports less the total value of imports - plays a role in determining how strong an economy is. Although you might expect an increase in imports to weaken an economy, in reality more imports means the economy is doing well, corporate profits are expanding, and, therefore, it's time to invest.
The exchange of goods and services is made possible by converting one currency to another. In a world where economies are closely tied together, fluctuations in interest rates can be tied to fluctuations in exchange rates. A weakening domestic currency will result in capital flowing into a country as its assets become cheap and its export potential increases, on the back of cheaper input costs of labor and domestic materials. This is similar to what was seen in the US over the last expansion from 1990 to 2001.
The ability to convert one currency to another has made international investing popular. Most countries place funds in countries other than their own, but when direct investment abroad decreases, it's usually a sign that domestic companies and individuals are rerouting funds to their home country to invest there. This often means that domestic reinvestment will continue in the following period, which in turn means that the exchange rate will strengthen and returns will be profitable. (However, a decrease in investment abroad doesn't necessarily indicate that domestic spending will increase; it could also mean that things are not doing well at home. From experience, I have found that as things go poorly in a country, the inhabitants flee with their capital, causing a foreign investment increase as they fear devaluation and poor returns domestically on their financial assets.)
Several mutal funds focus on foreign investments. Here are some for your reference:
Investing overseas has also gained popularity among individual investors, which has given rise to several mutual funds as well as exchange traded funds? (ETFs) that focus on specific countries or regions. After you decide which country is showing positive signs for stock returns, your investment choices are plentiful.
The Internet can be a good source of information for economic data from various countries. Here are a few websites.
United States Mexico Chamber of Commerce
It is interesting to note that inflation is not as significant as it is made out to be. Although classic economic theory offers inflation as the single most important factor in exchange rate and interest rate determination, I found that it didn't have much of an impact when it comes to predicting the future performance of an economy. Most people associate inflation news with coming interest rate shifts, which then translate into changes in the prospects for the financial markets. Perhaps inflation is two steps removed and therefore not useful for prediction, or it may be that it is a "lagging" indicator, in that an economy's changes have already been discounted by the market by the time the changes are reflected in the inflation figure. Either way, inflation was found to not even rank among the top half of the 71 factors considered to be likely candidates for predictive value.
Generally, interest rate movements, exchange rate fluctuations, and capital inflows are all interrelated. If you see increasing interest rates, a weakening exchange rate, and capital flowing into a country, it means that an economy is still moving in a positive direction.
Knowing where each of these factors stands relevant to past performance can put you one step ahead when deciding where you want to invest. The variables suggested here can help you cut through the endless amounts of information available from the Internet and your broker, keeping you focused on what is important. Inflation is talked about frequently and the data is readily available. Although this may make your broker appear smart when he or she gives you the data, it is useless for predicting your profit. To determine where to invest, stick to the top factors - interest rates, exchange rates, and capital inflows.
Karlis Sarkans, an engineer from the University of Toronto, received an MBA from the Wharton School of the University of Pennsylvania. He is completing his doctorate in economics. The findings presented here are from work he carried out together with the University of Latvia. Using a country timing methodology, Sarkans was awarded the title "Fund Manager of the Year" for 1997 by Mar New York, achieving the highest return worldwide in all fund categories. Sarkans continues work as a research consultant to Thornhill Wealth Management.
To find more information on investing overseas, visit our website, www.working-money.com. Relevant articles include:
"Easing Into Exchange Traded Funds," March 2001
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