Install

Get the latest updates as we post them — right on your browser

. Last Updated: 07/27/2016

Foreign Stocks, Bonds U.S. Investors' Best Bet

Other than gold-mining stocks, the best ideas for U.S. investors so far this year have been foreign bonds and foreign stocks. And many pros now believe that the foreign play has much greater staying power than the gold play.


The reason is simply that interest rates are continuing to fall in much of the world, and in many countries the rate decline has a ways to go before it catches up with the slide in U.S. yields last year. Falling yields automatically boost bond prices, and sooner or later they usually do the same for a country's stock prices.


With economic growth anemic in the United States and in Europe, bond yields here and there tumbled in 1995. But so far this year the U.S. bond market's rally has stalled, even including a buying binge last Tuesday. The yield on 10-year U.S. Treasury notes, for example, is 5.63 percent currently, up slightly from 5.57 percent at year's end.


In contrast, the yield on 10-year German government notes has plunged to 5.82 percent currently from 6.03 percent at year's end, as Europe's economic outlook has worsened and as investors have grown increasingly confident that the German central bank will continue to slash short-term rates.


For investors who are betting on foreign bonds in general, the logic goes like this: European yields have much further to fall based on the continent's economic weakness and, in countries like Germany and France, based on much lower inflation rates than even in the United States.


"German inflation is just 2 percent," notes Les Nanberg, who manages the Massachusetts Financial Services World Government bond fund in Boston. That means "real" interest rates are still much higher in Germany than in the United States.


In much of the rest of the world, meanwhile, interest rates should continue to fall as the Federal Reserve Board lowers U.S. short rates further. Additional Fed cuts may not help U.S. bonds rally significantly because the U.S. bond market already is expecting such cuts. But foreign bond markets that track U.S. rates, including many Third World bond markets, still may have room to come down.


The only bond market that doesn't look so hot: Japan's. The economy there is showing surprising strength, and that has been pushing yields up from their extraordinarily low levels.


Individuals who want to own foreign bonds can do so through mutual funds.


But some experts suggest that foreign bond funds are better used by speculators than investors. In other words, most pros don't suggest that you shift your U.S. bond holdings into foreign bonds, but rather that you buy foreign bonds with a small portion of your assets, and plan to exit when it seems that yields have bottomed (though that, of course, will be a very tough call).


One big risk with all foreign investments is that the dollar could keep strengthening, devaluing U.S. investors' overseas holdings. Partly because of the currency risk, many Wall Streeters say the smartest way to play declining foreign interest rates is with foreign stocks: They should get a nice kick from lower rates, and they can rally much more powerfully than bond prices -- potentially limiting any blow from currency changes.


Already this year most foreign stock markets have been surging. After two years of badly lagging the U.S. market, foreign shares are in many cases undervalued relative to their U.S. peers, foreign-stock bulls say.


In many Third World markets in particular, "economic growth has been good, but the stocks have gone nowhere in the last couple of years," says Mark Madden, manager of the Pioneer Emerging Markets stock fund in Boston. Contrast that with the U.S. market's 1995 surge, and the growing jitters about maintaining those gains.


With European interest rates tumbling, Japan's economy reviving and many Third World economies poised to grow again, foreign stocks now look much more interesting from almost every angle.