Global Stocks: Should You Pull Out?

It doesn't seem fair. The current financial crisis started in the U.S., but stock markets in the rest of the world have felt more pain.

That's not to say that American investors haven't felt the effects of the global sell-off, which accelerated on Oct. 6. U.S. investors have spent years shifting money into booming overseas markets, but now that strategy is backfiring as overseas stocks tumble.

The MSCI EAFE Index (EFA)—an abbreviation for Morgan Stanley Capital International Europe, Australasia & Far East—is off 36% this year, while the Standard & Poor's 500, the broad U.S. index, is down 28% by comparison. Stocks in emerging markets such as China, India, and Russia have performed even worse, with one measure, the Vanguard Emerging Markets index (VWO), off 45%.

Adding to American investors' global investing woes is a rising dollar. If U.S. investors buy equities priced in a foreign currency such as the euro, they benefit when the dollar weakens—which it has for the past few years—but are hurt when the dollar gains ground. The euro has fallen almost 16% from its peak of $1.60 this summer.

No Coordinated Effort

Overseas losses deepened on Oct. 6 on new evidence that the financial crisis is spreading worldwide, especially to banks in Europe.

While the U.S. has approved a $700 billion bailout plan for its financial industry, "It's pretty evident Europe has to make a coordinated effort to do something about the financial markets" as well, says Madelynn Matlock, portfolio manager of the Huntington International Equity Fund (HIEAX).

Economists have been worrying about a U.S. slowdown for the past year, but many professional investors now also expect a global slowdown. That's showing up in the stock markets' relative performance. "One can make the case that the U.S. is further along in this economic slowdown,"says Wasif Latif, who handles equity investments at USAA. One theory holds that "if we are quicker to go into the slowdown, we are quicker to get out of it," he says.

Managers of U.S. international equity funds have racked up huge losses in the past few months, and investors have responded by pulling their money out. According to TrimTabs Investment Research, investors have yanked $48 billion from international equity funds so far this year, with $31.7 billion in fund outflows since the beginning of September.

Hang in There

On Oct. 6 overseas losses mounted amid a steep sell-off in Europe. London's FTSE 100 Index tumbled 7.85%, while Germany's DAX Index dropped 7.07%. The S&P 500 fell 3.85% after battling back from even steeper losses earlier in the day. In reaction, many expect Asian indexes to fall further when they open on Oct. 7.

For years, professional investment advisers in the U.S. have urged clients to diversify holdings by including some exposure to international stocks. Is it time to change this advice?

Experts on international investing say selling foreign holdings is probably a mistake at this point.

"It's a little late now. The horse is out of the barn," says Rob Lutts, founder of Cabot Money Management. "If you didn't act earlier this year, hang in there. It's going to be a rough next couple months."

Bargain Time

However, portfolio managers say many foreign stocks are now trading at bargain levels. "There are tremendous opportunities out there," says Aaron Visse, portfolio manager of the Kensington Global Infrastructure Fund. "Stocks are not trading on fundamentals. In many cases, fundamentals are really being thrown out the window."

Huntington's Matlock agrees, saying: "Fundamentals right now are not playing a role in this market." However, she isn't sure when investors will stop panicking and look at fundamental measures like earnings potential or economic growth.

"There's a crisis of confidence in the financial system," she says. "There is plenty of cash out there. It's just not being deployed."

Nor are investors sure how well fundamental measures will hold up amid a global slowdown.

Hitting Poor Markets Hard

Of particular concern, several market experts say, are emerging markets like Brazil and Russia that are dependent on commodities. "The emerging markets are not all the same," Visse says.

However, all emerging markets have a common problem. In a time of crisis, investors "pull money out of high-risk areas," Lutts says. And poorer emerging markets are seen as much riskier than rich, developed nations.

The U.S. is suffering from a glut of housing, rising unemployment, catastrophic losses in its financial sector, high fuel prices, and weak consumer confidence. The odd thing is that, as the financial crisis spreads around the world, many investors seem to see the U.S. as a relatively safe haven.