Interest Rate Cuts May Ignite a Rally in Foreign Stocks

The plunge in U.S. interest rates has been the stock market rally’s principal fuel since October. Now, high rates overseas have just begun to show signs of cracking.

The message seems clear: Even if you’ve missed the U.S. stock rally thus far, you still have time to catch what could be a very strong foreign stock surge this spring, driven by sliding rates.

What’s more, you could earn a kicker from the weakened dollar, if it continues to fall in value even as overseas interest rates ease.

So far this year, foreign stocks have mostly lagged the U.S. market’s 10.3% rise, as measured by the Standard & Poor’s 500-stock index. But that’s what you see when you look at foreign stocks in their native currencies. Translate them into dollars, and the results are much different:

* The British market has risen 6.6% in the native currency this year, using Morgan Stanley Capital International indexes. But throw in the benefit of the weakened dollar, and a U.S. investor is up 10.2% in Britain.

* Likewise, the Japanese market has risen just 8.4% in yen, but it’s up 14.1% when converted into dollars for U.S. investors.

The equation is pretty simple: As foreign currencies get stronger versus the dollar, U.S. investors’ foreign stocks automatically rise in value, because they translate into more dollars when you bring your profits home.

How much further the dollar can drop is anyone’s guess. But even if it stabilizes or rises a bit from here, many foreign stock managers think that they’ll still produce hefty returns for their U.S. clients this year. At the very least, given the dramatic declines in many foreign markets last year (far worse than the U.S. market), this is a good time for long-term investors to buy in.

In recent weeks, three veteran foreign-stock fund managers visited clients in Los Angeles. Their strategies and viewpoints differ significantly, so they provide a lot of food for thought. Here’s a look at how each is trying to bring home big overseas returns to U.S. clients:

* Henry de Vismes, head of international investing for Citibank’s private banking unit in New York. De Vismes came to Citibank last May, after 19 years at the Kleinwort Benson International Equity mutual fund, one of the better foreign stock funds of the late 1980s. He’s got a definite opinion on the best place to be in 1991: “I think Japan will be the best-performing market this year,” he says, predicting that the Nikkei stock index, now 25,356.37, will reach 30,000 by year-end.

Although central bank officials in Germany and Japan still outwardly insist that they won’t cut their high interest rates, De Vismes doesn’t believe it. Economic growth is slowing worldwide, and that calls for lower rates, he says.

A key difference between U.S. and foreign markets is that U.S. investors discount the future, while overseas investors often don’t, De Vismes says.

Foreign markets historically are far more skeptical of what may occur--they want to see it. So although the U.S. market is looking ahead to the end of the recession, foreign markets are concentrating on rate fears. Especially in Europe, “the markets are not so sophisticated to look over the valley,” De Vismes says.

In April, with the start of a new Japanese fiscal year, De Vismes believes, interest rates there will begin to fall. Germany will follow sometime this summer, he says, when it’s clear to German authorities that inflation is no longer a threat. Overall, he looks for foreign markets to do substantially better than the U.S. market in the second half of 1991.

* Didier Miqueu, manager of the Capstone International European Plus stock mutual fund. While the average European stock fund dropped 4.4% last year, the $15-million Capstone fund eked out a 0.03% gain. Miqueu, based in Paris, was smart enough to cut back on German and Austrian stock holdings in the second quarter of 1990, before those markets plunged.

Especially in small, very illiquid foreign markets such as Austria’s, Miqueu says, “you need to be first to enter and first to sell” to make money.

Now, 36% of his portfolio is invested in Britain, 16% in France, 14% in Germany and 8% in the Netherlands, with the rest split among four smaller markets. Miqueu is bullish on prospects for a dramatic profit surge among European companies, perhaps by later this year.

Although the United States and Britain definitely are in recession, “there’s no recession in continental Europe,” he says. So corporate profits are only slowing there, rather than crashing, and they’re set to rebound nicely when economic growth worldwide resumes, Miqueu says.

French stocks in particular are cheap, he says--especially considering that “there is much room for interest rates to come down there.” While inflation in France is running at about 3% annually, long-term interest rates are around 9%, courtesy of neighboring Germany’s high-rate policy. A patient investor, Miqueu says France and Spain best illustrate his strategy: Where he sees promise, “we’re willing to be there and wait.”

* Alison Powell, London-based manager of the $86-million Financial Funds European portfolio. Fluent in German and French as well as English, Powell has been analyzing European stock markets for nine years. Her fund’s parent company is $35-billion IMI-MIM International Asset Management, which supports an analyst team that watches 600 European companies, Powell says. In a given year, 200 of those firms will be visited personally by an analyst. Powell then picks from the best of the bunch--and last year, her stock picking produced a 0.7% gain for the fund, while most European stock funds tumbled.

There’s a big advantage for an English manager who speaks German and French, Powell says, because “talking to (company) financial directors in their own language gives you much more skill in understanding the companies.” And in the still very disparate European market, she says, “you have to know your companies very well” to avoid nasty surprises.

Her portfolio now is 42% in British stocks, 12% in Germany, 8.5% in Switzerland and 7% in Spain. One of Powell’s major themes is to stick with companies that will benefit from what is going on internally in Europe--the infrastructure development that is crucial to the dream of an integrated Europe in 1992.

Some of those plays include home builders in Germany, freeway-construction firms in Spain and companies developing digital phone networks in Italy and France, she says.

While many European money managers remain on the sidelines, worried about the Persian Gulf War and its threat to European (and global) economic growth, Powell prefers to look to 1992 and beyond.

“To me, war is not an excuse for doing nothing,” she says.

A SAMPLING OF FOREIGN FUNDS Here are eight foreign stock mutual funds that have ranked highly during the past year and/or during the past five years. If you call a fund, ask in advance about any sales charges.

Minimum Total return: Fund/phone number investment 5 yrs. Yr.-to-date* Capstone European Plus 800-845-2340 $200 NA +9.6% Europacific Growth 800-421-9900 $250 +126% +8.0% Fidelity Overseas 800-544-8888 $2,500 +137% +6.1% Financial Funds: European 800-525-8085 $250 NA +7.3% GT Global Pacific 800-824-1580 $500 +192% +9.8% Kleinwort Benson Intl. 800-237-4218 $1,000 +112% +8.9% T. Rowe Price Intl. Stock 800-638-5660 $2,500 +132% +8.7% Templeton Foreign 800-237-0738 $500 +148% +9.1% Avg. international fund +98% +8.8%

* through Thursday close

NA: not available (fund hasn’t existed for 5 years)

Source: Lipper Analytical Services