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Foreign Stocks & Emerging Markets

Bargain-Priced Stocks Overseas

As foreign economies struggle, some investors see opportunity.

Foreign stocks have kicked off 2014 with some classic hesitation waltz moves. Japan’s Nikkei index is down 12% so far this year. Emerging countries sold off sharply in January and early February, then rallied. Only Europe seems to be waltzing straight ahead, returning 5% so far this year. Looking ahead, though, you may want to brace for another spin or two (returns and prices are as of April 30).

Japan on the mend. Prime Minister Shinzo Abe’s campaign to turn Japan’s economy around is bearing fruit. But as Abe starts on structural reforms, investors are becoming cautious. For example, Japan’s national sales tax rate (also known as a consumption tax) was raised on April 1 from 5% to 8%. The tax hike is likely to pinch consumer spending.

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But look for Japan’s central bank to ride to investors’ rescue by maintaining its aggressive easy-money policies, including continuing to buy government bonds. “As we’ve learned in the U.S., you don’t bet against governments” that open their wallets to stimulate growth, says Alison Shimada, co-manager of the Wells Fargo Advantage Emerging Markets Equity Income fund. For added safety, look for battered stocks at bargain prices. Toyota Motor (symbol TM) trades at just 9 times projected year-ahead earnings. Earnings are expected to rise by 5% this year, despite slow growth in Japan and Toyota’s recent recall of 6.4 million vehicles .

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Headwinds in Europe. European markets have recovered from the lows caused by the euro currency crisis. For stocks to keep rising now, analysts say, companies need to deliver bigger earnings. The potential is there. Shares are reasonably priced, and after four straight quarters of year-over-year earnings declines, profits rose in the fourth quarter of 2013. Based on estimated year-ahead profits, the price-earnings ratio for the Stoxx Europe 600 index is 14, compared with 15 for Standard & Poor’s 500-stock index.

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But Europe isn’t exactly firing on all cylinders. The euro-zone economy is projected to expand no more than 1% in 2014, and there is a risk of deflation, or a decline in prices, in debt-laden nations. “We’ve had a big rally based on economies going from bad to mediocre,” says Jed Weiss, manager of Fidelity International Growth fund. “Now the key is to identify ones that can go from mediocre to good.” The German market, for example, has greater growth potential and is cheaper than the broader region. Weiss favors countries that export to Germany, such as Belgium and Denmark. One top holding: Anheuser-Busch InBev (BUD). The Belgian beer maker, which acquired American icon Anheuser-Busch in 2008, is expected to generate 11% earnings growth this year and 13% growth in 2015.

Choppy emerging markets. After last year’s horrendous performance—the MSCI Emerging Markets index gained just 2%, a striking 30 percentage points behind the U.S. stock market—and the pullback early this year, valuations are attractive, even with the recent rebound. The MSCI index trades at just 10 times projected 2014 earnings, slightly below the ten-year average of 11.

But be prepared for plenty of volatility, maybe even more than usual. In particular, com­panies are still adjusting to slowing growth in China. “I would look for pretty ugly earnings out of the emerging markets for the next quarter or so,” says Ben Kirby, co-manager of Thornburg Investment Income Builder fund. “But once earnings bottom, I think you have a really robust case for the next bull market.” Our favorite developing-markets fund is Harding Loevner Emerging Markets (HLEMX), a member of the Kiplinger 25. It has big weightings in South Korea and India.

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