Even after the late February 2007 market meltdown triggered by a 9% one-day drop in Shanghai, investors continue to seek returns in emerging markets. Given the much higher growth rates in places like India and China, US investors are asking how they can participate. There are a number of ways to invest in these hot markets without you or your money leaving home. One is through an American Depositary Receipt (ADR).
A Way to Get in the Game
Like exchange-traded funds or mutual funds, ADRs trade on US exchanges and are denominated in US dollars, which means you can trade them through your brokerage account, IRA, or 401(k).
Unlike domestic stocks, ADRs are based on the underlying stock in the country of origin. This means that it will enjoy any rise (or suffer any fall) in the stock, and since the underlying is traded in a foreign currency, changes between that currency and the US dollar are also included in the calculation.
For example, the Australian All Ordinaries Index has more than doubled since the beginning of the global bull rally in mid-March 2003. Additionally, the Australian dollar has appreciated 50% against the US dollar over the same period. The US investor who bought the Australian All Ordinaries in March 2003 would be up a total of 188%.
Just a Matter of Currency
The Australian dollar has been a strong performer over the past 4 years, gaining 50%. So let's take a look at an Australian ADR over the same period. Mineral exploration and processor BHP Billiton Group (BHP) is a great example. In mid-March 2003, it was trading just around $11. By February 26, 2007, this ADR was trading above $46 on the New York Stock Exchange with roughly half of that 330% gain thanks to appreciation in the Australian dollar.
Buying just any ADR is not a good idea, as holders of Thailand stocks found out in late 2006: The Thai government brought in myopic lock-up rules restricting foreign investment in December. Thai stocks dropped 18% in one day as investors fled en masse.
Thanks to a river of liquidity flowing through global markets together with the explosion in the number of hedge funds, more dollars are chasing fewer opportunities, creating overheated markets. Even after a global correction, investor complacency remains high as measured by a number of indicators, increasing the chance of a more protracted meltdown in the futureâ€” if history is any guide. The big question is when.
It could be months or even years. Do investors sit on their hands waiting? The other option is a number of markets offering good appreciation potential, and these include those rich in commodities like Australia, Canada, and New Zealand. Other promising candidates include emerging economic powerhouses China and India as well as some smaller countries such as Taiwan. And, after more than 15 years of recessions and deflation, Japan is again looking good.
With odds of US dollar weakness continuing, ADRs provide a great vehicle for diversifying your nest egg while not having to leave the safety and comfort of the stock markets at home.
Matt Blackman, market analyst for www.TradingEducation.com, a free educational Web site for traders and investors, is a technical trader, author, reviewer, and keynote speaker. He is also the host of www.Electionomics.com devoted to tracking the impact of the election cycle on markets. Matt is a member of the Market Technicians Association and the Technical Securities Analysts Association.