Investor Thirst for Foreign Stocks May Be Speeding Dollar's Decline

By FeaturesDow Jones Newswires

Global investors are shifting more of their money overseas, betting that even as the U.S. stock market reaches new highs a resurgent global economy creates greater opportunities elsewhere.

That rising tide of capital chasing foreign stocks may even be helping drive the dollar to more-than-three-year lows, some analysts say.

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The share of U.S. equities in global portfolios has fallen back to near its lows in early 2016, before a surge of interest in the U.S. market drove investor flows there, according to the Institute of International Finance.

As of Tuesday, investors had withdrawn roughly $20 billion from U.S. equity funds since the start of 2017, while pouring $42 billion into funds that invest in continental Europe and $55 billion into Japanese stocks, according to fund-tracker EPFR Global.

Some of the money exiting the U.S. appears to be heading into the developing world, too. Net inflows into emerging-market bonds and equities reached an all-time high in 2017 at $650 billion, according to Capital Economics. Emerging-market equity flows for the week ending Jan. 24 were the second highest on record.

Since the 2008 financial crisis, global investing "has been a U.S.-centric world," said Alain Bokobza, head of global asset allocation at Société Générale.

Now with the U.S. economic recovery likely past its peak, strong prospects for growth around the globe, and the dollar fragile, that could be changing, he added.

Despite the S&P 500 index rising to another record close on Friday, the shift away from U.S. stocks has already benefited global investors. Foreign stock returns edged out those in the U.S. last year for the first time since 2012, and overseas stocks are on pace with U.S. stocks this year, with many benchmarks around the world trading at multiyear or record highs.

"If before, the U.S. was the best house in a bad neighborhood, the neighborhood just got better," said Brent Schutte, chief investment strategist at Northwestern Mutual Wealth Management.

U.S. equity funds had a brief resurgence in flows toward the end of 2017, as investors bet President Donald Trump's new tax laws would benefit American companies. That spike in interest has mostly petered out, however, compared with the rush for international stocks.

Global investment flows may also help explain a phenomenon that has puzzled many currency analysts: why has the dollar declined around 9% in the past year despite solid U.S. data, a corporate tax cut expected to lure cash back to the U.S., and rising Treasury yields?

Over the past 12 months, the euro has gained roughly 17% against the dollar and the Japanese yen has risen 5%. That's even as the Federal Reserve has raised interest rates three times over that period and signaled that it plans to do so three more times this year if the economy holds up.

Fixed income flows typically have a more pronounced impact on currency movements than stock flows, analysts say. Expectations of relative interest rate dynamics and economic growth can matter even more.

But some investors now think the especially large equity flows moving around the world may be having a bigger-than-usual impact on the dollar, as equity markets draw record inflows that far outpace bonds. To purchase a stock abroad, an investor must first buy the currency of the other country which would help put upward pressure on it.

"Shifting equity capital flows into non-U.S. markets has tended to erode the value of the dollar and support the value of other currencies," said Larry Hatheway, chief economist at GAM Holding, a Zurich-based money manager.

While the relationships are complex, some periods of dollar strength have coincided with a growing preference for U.S. equities in global portfolios. The dollar's strong run from 2011 to 2016 mostly came at a time of strong U.S. equity performance and equity inflows that pushed up the share of U.S. stocks in global portoflios.

"These days it is all about flows," said Krishna Memani, chief investment officer at OppenheimerFunds in New York. Mr. Memani said he has been gravitating more toward stocks outside the U.S. for over a year, finding better growth opportunities and more attractive valuations.

The new fund flows reverse a positioning shift that occurred in 2016, when investors were putting their money into the U.S. stock market, avoiding Europe and emerging markets. They worried then that a range of political risks could destabilize Europe, Japanese growth remained stalled, while weak commodity prices and a vulnerable Chinese economy made emerging markets look especially risky.

But the climate has quickly changed. Oil prices have jumped 159% from early 2016, metal prices are higher, and the Chinese economy accelerated for the first time in seven years in 2017. Last year, all 45 countries tracked by the Organization for Economic Cooperation and Development grew in sync for the first time since the crisis.

Equity valuations are also more attractive abroad than in the U.S., many investors say.

The S&P 500 currently trades at 18.5 times forward earnings, up from 16.8 at the start of 2017, which is expensive both for that index historically and when compared with most global peers. The Stoxx Europe 600, for instance, trades at 15.2, up from 14.9, and Japan's Nikkei has moved to 17.6 from 17.5 over the same period.

Emerging-market equities now represent around 13% of global investors' equity portfolios, the highest since June 2015, and 11.8% of their bond portfolios, the highest since 2014, according to the Institute of International Finance.

Antoine Lesne, who runs an exchange-traded fund strategy at State Street Global Advisors, said many of his European clients "are going back home with faith in their economy."

"Where Europe and emerging markets are in the economic cycle certainly suggest they've got further to run than the U.S.," said Gautam Batra, head of investments at Mediolanum Asset Management in Ireland.

Write to Riva Gold at riva.gold@wsj.com

(END) Dow Jones Newswires

January 28, 2018 11:56 ET (16:56 GMT)

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