If you’ve had a portion of your portfolio invested in international markets, you have probably enjoyed a nice ride for the first half of this year, even after adjusting for the currency effects of investing in dollars.
Those investments may have been sitting less pretty in recent weeks, as China entered bear market territory, the Greek debt crisis has come to a head, the dollar just keeps getting stronger, and the lifting of economic sanctions on Iran could impact global oil markets. It’s enough volatility to make some investors pause and question whether international investments are still a smart play, especially as global markets become a growing part of Americans’ stock holdings.
Last year, even with the strong U.S. dollar, world equity funds received $85 billion in new investment from Americans, while domestic equity funds had outflows of $60 billion, according to the Investment Company Institute.
If your portfolio has gotten over-weighted in international equities, with holdings comprising more than 30 percent or so of your allocation, it may make sense to rebalance. But beyond that, proceed with caution. In general, it’s not a great idea to make big changes to your long-term investments based on your emotional reaction to news. “If this kind of turbulence gets you so upset that you want to sell, then your asset allocation is wrong,” says Rob Martorana, a portfolio manager at Right Blend Investing.
Here are three key factors to consider:
1. The current issues are likely short-term. If the current Greek debt crisis sounds familiar, that’s because the country has been on the brink of default several times over the past few years, and each time it’s eventually gotten a bailout. Those crises however have given Europe a chance to prepare and take measures to limit the potential contagion in the case of a default. Even if the country goes through with a Grexit, many economists believe that the European economy would continue to grow.
Related: China Calls for Greek Debt Talks to Continue
“There’s going to be a lot of volatility because of the Greece situation over the next couple of days and weeks,” says John Praveen, chief investment strategist with Prudential International Investments Advisers. “But looking beyond that noise, we are constructive on equity markets, especially international markets.”
Even though China’s stock market lost more than 20 percent this week, prices are still at levels twice as high as the beginning of the year. A slowdown in China’s growth is not necessarily a bad thing as the economy continues to mature, says Chris Hyzy, chief investment officer at U.S. Trust. “Ultimately, China’s goal is not to grow 12 percent a year anymore,” he adds. “It’s to grow at a more consistent 5 percent to 7 percent.”
2. U.S. economic growth is slowing. GDP is projected to have grown 2.2 percent in the second quarter, following a small dip in the first quarter of the year, and the pace of growth in corporate profits is starting to slow down as well.
Meanwhile, international markets are projected to expand at a far faster speed, making them more attractive for U.S. investors looking to diversify. Plus, European stocks have relatively favorable valuations, while U.S. stocks are no longer the bargain they were a few years ago.
3. Foreign central banks are keeping interest rates low. While the Fed is contemplating an interest rate increase, the European Union and Japan are both trying to fight off inflation and a boost by injecting liquidity into their markets and keeping interest rates low and their currencies weak. “When you have desynchronization of monetary policy, you want to start moving away from the country that’s raising interest rates and toward the countries where rates are going to stay low,” says Alan Robinson, an analyst with RBC Wealth Management.
Low interest rates abroad are good for corporations based in those countries, because it’s cheaper for them to invest and grow their businesses. Credit conditions for European businesses of all sizes have started to ease, thanks to the ECB’s quantitative easing program, according to the International Monetary Fund.
That should push stocks there higher, despite political unrest and general uncertainty. “When markets have issues around the, that’s when they tend to be more attractive investments,” says Sameer Samana a senior global strategist with Wells Fargo Investment Institute. “That’s what creates the opportunity. International and emerging markets are where the growth will come over the next decades, but you have to go in with a long time horizon, because they can be volatile in the shorter term.”
The downside for American investors, of course, is that weak foreign currencies mean a stronger dollar, which can eat away at returns. Look for a currency-hedged fund to help offset that risk.
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