4 Foreign Funds to Profit from Global Turmoil

Terrorists are ravaging Syria and Iraq, stoking fears of an ever-wider conflict in the oil-rich Arab world. Vladimir Putin has invaded Ukraine, threatening to ignite an economic war with Europe. Eurozone economies are faltering and flirting with deflation.

Is this the time to buy foreign stocks? I think so. Here’s why. Sir John Templeton, a pioneer in investing overseas, once said to buy “at the time of maximum pessimism.” Templeton and a host of others, including Warren Buffett, made their fortunes, in part, by going against the crowd.

What’s more, hard numbers back up the case for European and other foreign stocks. Foreign stocks are cheap relative to U.S. stocks—far cheaper than they deserve to be based on the admittedly dismal fundamentals, says the Leuthold Group, a Minneapolis-based investment research firm. Leuthold projects that foreign stocks will return an average of two percentage points per year more than U.S. stocks over the next seven to ten years. Leuthold predicts that U.S. stocks will deliver returns only in mid single digits over that span.

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Consider price-earnings ratios based on analysts’ earnings estimates for the coming 12 months. The MSCI U.S. stock index (a broad market index similar to Standard & Poor’s 500) trades at a P/E of 18—a little above its long-term average but hardly wildly overpriced. The MSCI World Ex-U.S. index, which reflects developed markets outside the U.S., trades at 15 times estimated earnings, 15% less than the U.S. market’s P/E.

The biggest bargains of all are in emerging markets. The MSCI Emerging Markets index trades at a P/E of just 12—one-third cheaper than U.S. stocks. Of course, emerging markets face many problems, including government ownership of portions of many companies, but markets with a P/E of 12 are hard to pass up.

Truth be told, Leuthold doesn’t think forward P/E ratios are particularly helpful in projecting future stock prices, mainly because analysts tend to be over-optimistic with their profit projections. Doug Ramsey, chief investment officer at Leuthold, says “normalized” P/Es often do accurately foretell stock prices. To normalize earnings (the E in P/E) so they’re not distorted by the ups and downs of the economic cycle, Leuthold averages five years’ worth of earnings.

By this measure, U.S. stocks are pricey. The MSCI U.S. stock index trades at a P/E of 23. The MSCI ex-U.S. index trades at a P/E of 19—not low, but low compared with the U.S. And the MSCI Emerging Markets index boasts a P/E of just 14.

Ramsey says the reality is probably even more favorable for foreign stocks than the numbers indicate. U.S. corporate profit margins are at record highs. Margins are more likely to fall rather than rise, making it more difficult for companies to boost earnings. Moreover, the U.S. is later in the economic cycle than most of the rest of the developed world. Earnings in most foreign countries, Ramsey says, haven’t recovered as fast as U.S. earnings since the great recession.

What to do? Leuthold’s global allocation model recommends 55% in foreign stocks. Ramsey says a U.S.-based individual investor should put 30% to 35% in foreign stocks, with about one-quarter of that in emerging markets. I think those are sensible allocations. Says Ramsey: “Regardless of your opinion on Europe, the bad news is already in the price. Consequently, we should see excess returns in foreign stocks.”

Below are my four favorite no-load foreign stock funds.

Dodge & Cox International Stock (DODFX) has offered a somewhat bumpy but ultimately profitable ride. Over the past ten years, it returned an annualized 9.8%--an average of nearly two percentage points per year better than the MSCI World All-World ex-U.S. index. The fund, a member of the Kiplinger 25, is slightly more volatile than the index and currently has almost 20% of its assets in emerging markets. Dodge & Cox is a value shop, meaning its managers tend to favor stocks that are cheap in relation to a company’s earnings and other key measures. And the managers are patient: They typically hold stocks for long periods and tend to stay at the firm for their entire careers. Annual expenses are 0.64%. (All returns are through September 3.)

Harbor International (HIINX) lost a brilliant manager when Hakan Castegren, who launched the fund in 1987, died in 2010. But he spent years tutoring the fund’s three comanagers in his discipline. Over the past three years, the fund bested the MSCI index. And over the past ten years, it returned an annualized 9.5%. Like Dodge & Cox, the fund is slightly more volatile than its benchmark, but, in contrast to Dodge & Cox, Harbor favors companies with fast-growing earnings and tends to shun emerging markets. Expenses are 1.11% annually.

Harding Loevner Emerging Markets (HLEMX) has produced superior returns with less volatility than the MSCI Emerging Markets index. Over the past ten years, it gained an annualized 12.8%--an average of 0.3 percentage point per year better than the index. The fund’s veteran managers favor high-quality companies. The fund currently has 10% stakes in both Brazil and India, overweights compared with the index. Expenses are 1.47% a year. The fund is a member of the Kiplinger 25.

Vanguard Total International Stock ETF (VXUS) is a solid pick if you’re looking for an index fund. For an annual cost of 0.14%, this exchange-traded fund gives you the entire world outside the U.S., including a 19% stake in emerging-markets stocks. The fund tracks the FTSE Global All Cap ex-U.S. index, which includes Canada, a country that many developed-world benchmarks inexplicably exclude. If you have $10,000, you can buy Vanguard Total International Stock Index Admiral (VTIAX), a mutual fund version of the same product.

Steven T. Goldberg is an investment adviser in the Washington, D.C. area.