5 Things to Consider When Investing Abroad

In the US markets right now, the warning signs are flashing bright red… So, it’s time to take a good hard look at your global diversification strategy.

US stock markets have nosedived since mid-February. The S&P 500 touched correction territory (10% below peak). The Nasdaq was down 11%. The Russell 2000 index, which represents most listed companies in the US, is also in correction mode.

This got me thinking about where else to put my money. Besides being the “Second Passport Guy,” I’m also an economist and economic historian. I spent a decade as a stock market analyst. So, when people ask my thoughts about investing outside North America, I can do more than say, “Yes, it’s a good idea.”

When considering where to invest globally, I focus on five things:

1. Comparative valuation: Can you buy more future earnings per dollar in one market (say, Southeast Asia) as opposed to another (say, the US)?
2. Foreign exchange (forex) rates: Will your future capital gains and/or earnings from a foreign investment benefit from exchange rate moves in your favor (say a strengthening euro vs. the dollar)?
3. Growth prospects: How rapidly can we expect foreign economies and companies to grow compared to the North American market over the next decade?
4. Risk: Even though returns abroad may be lower, a better risk profile and lower volatility may compensate for that.
5. Likely growth in stock valuations: This is a function of the other four items.

Here’s a table that reviews these criteria for select regions and countries:

The first thing to note is that US stocks are the most highly valued in the world, despite the fact that US economic growth will be slower than other countries and regions. In other words, it’ll take twice the time to recoup your investment in a US company compared to Southeast Asia.

US stocks are overvalued because US monetary policy has been extraordinarily loose over the last 15 years (money printing and generally lower interest rates), providing lots of liquidity to pump up stocks. But that cannot continue forever.

The second thing is that, in my view, the ideal combination of low risk and higher returns will be found in Japan, Southeast Asia, and India. Japan’s economic growth won’t be much to write home about, but Southeast Asia is likely to grow rapidly, as will India. On the other hand, the value of the Indian rupee is likely to fall relative to the dollar over the next decade.

If I had to pick just one region, I’d probably go with Southeast Asia. That’s because countries there are rapidly absorbing the investment that has been going to China for the last 20 years. Thailand, Vietnam, Indonesia, and Malaysia are rapidly building the capacity to take over from Chinese supply chains. As foreign investors pump money in for that purpose, the value of their currencies is rising, increasing your investment returns in dollar terms.

How can you do this? After all, opening a brokerage account in a foreign country takes a bit of fancy footwork.

One is to buy “ADRs,” or American Depository Receipts. These are tickers traded just like stocks. They are an indirect shareholding in foreign companies. Unlike stocks, you don’t own shares in the company; you own claims on the ADR issuer’s own foreign stocks. The trick is that you need to evaluate the prospects of individual countries, as opposed to entire regions.

The second way is to buy exchange-traded funds (ETFs) representing specific countries or regional markets. For example, if you wanted to get broad exposure to Southeast Asian markets, you could invest in a variety of ETFs trading on the US stock market. As always with ETFs, you want to target those that have the lowest expense ratios, lots of assets under management, and good liquidity.

For a generation now, US investors have had the luxury of having the best performing stocks in the world right in their backyard. That’s starting to change. There’s no better time to start diversifying your investments across the globe.