Foreign markets blazing trail

5/5/2008


Headed into the current economic downturn, pundits speculated whether the U.S. economy would finally decouple from the rest of the world. Had we seen the end of the days in which the world caught a cold every time America sneezed?

There are reasons to think that American and foreign markets no longer share the tight relationship seen in the past.

America makes up a smaller percentage of the world economy than it once did, and demand for goods and services from such emerging economies as India and China is booming. In addition, the correlation between market returns in the U.S. and those in other developed economies showed a significant decrease from February 2005 to February 2007.

Mutual-fund performance numbers also tell a tale of diverging economies. According to Lipper, foreign-stock funds have outpaced U.S. equity funds over the last one, two, three, five, 10, and 15 years.

But investors who salivated over those fund returns and plowed their money into foreign funds discovered this year that chasing hot markets doesn’t always pay off. Those who claimed the U.S. economy’s troubles would not bleed over into foreign markets were wrong. Of the 20 foreign regional indexes tracked by Morningstar, 19 are in the red this year, hurt by many of the same concerns weighing on U.S. stocks.

While the correlation between the U.S. and many overseas markets in developed regions remains fairly high, foreign stocks provide substantial diversification benefits for a U.S. equity portfolio. Even the stock markets in developed economies in Western Europe do not move in lockstep with U.S. stocks, and emerging-market stocks often diverge drastically.

For most investors seeking both strong returns and moderate risk, holding 15% to 25% of equity portfolios in foreign stocks is appropriate. The Forecasts recommends three foreign-stock funds. T. Rowe Price International Discovery ($45; PRIDX) invests in small-cap and midcap growth stocks, mostly in developed economies. Vanguard Emerging Markets Stock Index ($32; VEIEX) contains a blend of large-cap stocks in emerging markets. And the Vanguard International Value ($41; VTRIX) fund holds large-cap value stocks in developed markets.

The Forecasts recommends two foreign stocks for purchase, Manulife Financial ($39; NYSE: MFC) and AstraZeneca ($41; NYSE: AZN). For most investors seeking additional international exposure, mutual funds represent the safest strategy. But for investors looking to diversify overseas using common stocks, the five issues below have appeal.

Our top foreign stock
Manulife Financial ($39; NYSE: MFC), Canada’s largest life insurer, has extensive operations in the U.S., Japan, and other Asian countries. Last year, the company’s Canadian businesses represented just 28% of revenue, and foreign operations provided all of the growth. Premiums generated 56% of 2007 sales, while investment income accounted for 27%. Most of the rest of Manulife’s revenue comes from fees for wealth management.

In the U.S., Manulife operates under the John Hancock Financial Services brand, providing a variety of insurance and investment products. Last year, U.S. sales rose at low- to mid-single-digit rates. Asia is Manulfe’s strongest growth driver. Manulife’s Asian operations started in Hong Kong in 1897. Since then, the company has spread to the Philippines, Singapore, Indonesia, Taiwan, China, Japan, Vietnam, Malaysia, and Thailand, where it provides life and health insurance and wealth-management services. Asian sales climbed 15% last year and should continue to grow at double-digit rates.

Consensus estimates project 12% per-share-earnings growth in 2008 and 15% growth in 2009. Selling for just 13 times 2008 earnings, Manulife is a Focus List Buy and a Long-Term Buy.

Other intriguing names
While all four of the companies below earn high Quadrix® scores and offer excellent growth potential, there are reasons why none has been added to the Monitored List. Differences in accounting principles and regulatory oversight make foreign companies’ financial statements — and the growth and valuation statistics drawn from them — more difficult to interpret. Foreign stocks in general are more difficult to analyze, and their risks can be tough to quantify.

As metals prices have risen over the last two years, so have the fortunes of ArcelorMittal ($87; NYSE: MT) of Luxembourg, the world’s largest steelmaker. The company recorded sales of more than $105 billion in 2007, up from $28.13 billion in 2005, thanks in large part to the 2006 merger of Arcelor and Mittal. Per-share earnings have grown at an annualized rate of 62% since 2002.

ArcelorMittal has operations in 20 countries and sells to heavy industries in 170 countries. Last year the company produced more than 130 million metric tons of steel. ArcelorMittal produced roughly 46% of its steel in Europe but also has extensive production assets in the Americas, Africa, and Asia.

Consensus estimates project 19% sales growth and 14% per-share-earnings growth in 2008. ArcelorMittal earns a Quadrix Overall score of 99, but we only have data for about 77% of the statistics that make up the score. ArcelorMittal is not rated.


Montreal-based CGI Group ($12; NYSE: GIB) provides information-technology consulting and outsources such business processes as payroll and document management. The company generated 59% of sales in its home market of Canada in fiscal 2007 ended September. Another 33% came from the U.S., while Europe and Asia combined to provide 8%.

In the March quarter, CGI earned C$0.21 per share, up 12%. Revenue rose 5% to C$949 million excluding currency fluctuations. The company booked $1.1 billion in new contracts, renewals, and extensions, boosting the backlog to more than C$12 billion, or about 3.2 times annual revenue.

Consensus estimates project per-share earnings of $0.83 in fiscal 2008 and $0.91 in 2009. CGI Group, with a Quadrix Overall score of 96, is not rated by the Forecasts, although sister publication Upside rates CGI a Buy.


Chicago Bridge and Iron ($41; NYSE: CBI), founded in the city whose name it bears, is now based in the Netherlands. CB&I provides engineering and construction services, mainly to companies in the energy and natural-resource industries. Booming energy markets have helped beef up the backlog to $7.70 billion. Last year, both revenue and per-share profits rose more than 39%. In November, CB&I paid $950 million for Lummus Global, which provides technology to energy producers.

A broad business mix helps insulate CB&I from weakness in any one sector. The company builds refineries and power plants, as well as facilities to process and burn liquefied natural gas. CB&I also makes steel plate structures to store oil and water.

Nearly half (45%) of CB&I’s 2007 sales came from North America. Europe, Africa, and the Middle East provided another 29% of sales, with 14% from Central and South America and 10% from Asia. Consensus estimates project 54% per-share-earnings growth in 2008 and 20% in 2009, but March-quarter profits came in well below estimates. Chicago Bridge & Iron, not rated, earns a Quadrix Overall score of 96.


Brazilian miner Vale ($37; NYSE: RIO), formerly known as Companhia Vale do Rio Doce, has benefited from the rise in commodity prices. Last year, sales rose 29% to $33.1 billion while per-share earnings jumped 79%. From 2003 through 2007, Vale has increased its total output at a 12% annualized rate, powered by a mix of acquisitions, new projects, and productivity improvements.

Vale sells a variety of industrial metals. Iron is the company’s top seller, followed by nickel, aluminum, and copper. More than 40% of revenue comes from Asian markets, with China alone accounting for 18% of 2007 sales. The Americas contributed 34% of 2007 sales and Europe 22%.

The company expects growth to slow in 2008 but counts on emerging-market customers to support continued solid demand. A combination of supply problems (metals are becoming harder to find) and a need for new infrastructure in many markets should keep inventories low and prices high. Vale’s Overall score is 98, and we have data on 76% of the statistics used to calculate the Overall score. Vale is not rated.


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