Global Warming? Some International Markets May Heat Up in 2001 - TheStreet

It's been a terrible year to go abroad. To invest, that is.

The year 2000 has not been kind to international mutual funds. Every one of

Morningstar's

international stock fund categories is in the red this year, with the average foreign stock fund down 18.7%. Some regions have been hit even harder: The average Japan fund is down by 34%.

This performance might make investors want to flee international funds faster than

Pat Buchanan

at a free trade rally. But many international fund managers are optimistic that the worm could turn for many regions in 2001.

A slowing U.S. economy and the potential for a weaker dollar and lower interest rates in the U.S. next year could bode well for international investment next year, particularly in Europe and emerging markets, say some fund managers.

"We're actually bullish in markets outside of the U.S. and Japan," says David Herro, portfolio manager of the $753 million

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Oakmark International fund, which bucks the trend and is up around 6% this year.

Value investor Herro says he has been able to find many solid international companies at attractive prices, particularly in Europe, where his fund holds 67% of its assets. At the end of September, the fund's top holdings included British drinks producer

Diageo

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and supermarket chain

Somerfield

.

Herro says European stocks have a lot going for them in the next year, including expectations of a stronger euro, the simplification of tax codes in many countries, a more flexible labor force and the privatization of pension plans, a move that has prompted his fund to shift 18% of its assets into international banks and thrifts.

Similarly, the $230 million

(MAIEX)

Merrill Lynch International Equity fund had around 11% of its holdings in financial services stocks, its largest sector investment, and about 59% of its assets in Europe at the end of September.

The fund's senior portfolio manager, Jeremy Beckwith, says he's more bullish on Britain than he is on continental Europe, especially since a rise in the euro could drain some of the profitability from European exporters. The fund's top holdings at the end of September included two British stocks, mobile phone giant

Vodafone

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and oil conglomerate

BP Amoco

(BP) - Get Report

.

"Vodafone clearly is going to be the No. 1 mobile phone company in the world," says Beckwith, who applauds the company's ambitious acquisition strategy and low debt level. Beckwith, whose fund is off 20.5% this year, also likes two British banks,

Barclays

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and the

Royal Bank of Scotland

.

Further afield, some fund managers say next year could see a resurgence in emerging market stocks if the

Federal Reserve

decides to cut interest rates.

"If there is favorable liquidity flow put into the global financial system, it tends to benefit emerging markets," says W. George Greig, manager of the $366 million

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William Blair International Growth fund.

Greig, whose fund had about 6.4% of its assets in emerging markets at the end of September, says he'll be keeping a close eye on larger, more established countries in the sector, like Mexico, Brazil, China and India.

That said, he has been getting more defensive in his portfolio, selling off tech stocks like the Netherlands'

Philips

(PHG) - Get Report

and Japanese blue-chip

Kyocera

(KYO)

in favor of companies like Swiss financial group

Zurich Allied

and British supermarket chain

Tesco

. He says he would follow the same strategy in emerging markets, buying into consumer-oriented stocks and financials.

"At this point, the areas that look attractive are the areas that look safe, and they're the typical defensive sectors that value investors love and cherish," says Greig.

Sentiment seems to be more mixed on Asian markets. Many fund managers say it may be a while before Japan gets back on its feet, since economic reforms have been slow in coming. Meanwhile, the Tokyo stock market hit a 22-week low on Wednesday amid concern that a U.S. slowdown would hit Japanese exports.

"Japan still has massive, massive problems," says Oakmark's Herro. "The valuations given the quality of the companies just aren't that attractive."

Other Asian countries could hold more promise.

Merrill Lynch's

Beckwith says he will be looking at Hong Kong, which has its dollar pegged to the greenback and could see a boost in exports if it declines. He says he's looking at property stocks and those of companies with exposure to mainland China, like

China Mobile

(CHL) - Get Report

.

When all is said and done, fundamentals might be looking up for many regions, but investor sentiment could play a big role in determining international performance. Most managers agree that those who invest internationally should not have a short time line and expect some bumps along the way. And if the U.S. economy does slow as much as some analysts fear, international exposure might help. The trick is getting individual investors to look beyond the negative returns of 2000 -- a task that could prove difficult.

"American investors have become fairly versed in the ups and downs of the mutual fund world," says Morningstar analyst Gabriel Presler. "That said, I don't know whether they'll be buying funds when they're down. It's very difficult to do."