The Potentially Huge Impact Of Foreign Investment On The Current Market
Not
since King George III of England ruled over the American colonies
have foreigners had a greater financial claim on the U.S. than they do today. But instead of staking
their claim by royal proclamation, these days foreigners are getting their piece
of the American pie
by buying into the U.S. economy, showing an insatiable appetite for U.S.
companies, equities, and bonds.
In
this lesson, I will show you where the money goes, how it could have an impact
on the stock market, and how you can keep track of Foreign Investment data.
At
$400 billion, it recently stood at a record, in terms as both dollars and as a
percentage of the U.S. economy (4.1%). This
basically means that the U.S. is buying far more goods and services from the
world than the world is buying from the U.S. In
other words, net-net, more money is coming into the U.S. than is going out.
This is not to say that the secular trend will reverse, just that
cyclical forces could become the dominant influence in the short run.
If it does, this would:
-
raise the
cost of capital -
hurt
financial markets -
raise the
cost of imports -
reduce U.S.
competitiveness, and -
weaken the
dollar
That
would be a major event, indeed.
“MS Mincho””>
A closer look at U.S. capital flows requires scrutiny of four key areas:
equities, fixed income, mergers and acquisitions, and foreign direct investment
(FDI). Combined with trade data, these
top cash flow areas form a clear picture on the major forces that shape the
performance of the U.S. dollar. Currently,
all four cash flow “hot spots†point to mammoth capital inflows to the U.S.
that seem impossible to sustain in the current economic environment.
Capital
Inflows to U.S. ($ billion)
| Year | Equities |
Corporate bonds |
Agency bonds |
Foreign Direct Investment |
| 1994 | $ 0.9 | $ 38.0 | $ 21.7 | $ 47.1 |
| 1995 | $ 16.6$ 58.1 |
$ 28.7 | $ 59.6 | |
| 1996 | $ 11.1 | $ 83.7 | $ 41.7 | $ 89.0 |
| 1997 | $ 66.8 | $ 84.0 | $ 49.8 | $109.3 |
| 1998 | $ 43.8 | $122.4 | $ 54.6 | $193.4 |
| 1999 | $ 94.3 | $158.9 | $ 94.1 | $275.5 |
| 2000 | $174.9 | $184.1 | $152.8 | $316.5 |
| Past 12 mos. |
$168.9 | $245.8 | $160.6 | $297.4 |
From
a paltry $900 million in 1994, net foreign purchases of U.S. equities rose
sharply to $94.3 billion in 1999 — and to a record $175.0 billion last year
(see above table). For perspective, note
that equities saw mutual fund inflows of $187 billion in 1999, and $157 billion
in 1998.
In April 1999, for example, foreign purchases of a then-record $17.6
billion helped drive the Dow higher by a whopping 1,003 points.
Then, in November 1999, when foreign purchases hit a new record of $18.4
billion, the Nasdaq — the new market leader at that time — rose 12.2%.
In August of 2000, $24.0 billion of inflows spurred gains of 6.6% in the
Dow and 11.7% in the Nasdaq.
As the table shows, foreign investment in corporate and agency bonds has
grown explosively over the past couple of years.
Foreign investors now own over 20% of all corporate bonds, compared to
about 12.5% five years ago. Foreign
investors now hold more corporate bonds than do U.S. households, and they rank
just behind U.S. insurance companies as the biggest holders of corporate bonds.
That’s a complete switch from six years ago when life insurance
companies owned twice as many agencies as foreign investors.
Notably, the next biggest holder of U.S. Treasuries is the Federal
Reserve, with roughly $500 billion in holdings.
Foreign direct investment (FDI), for example, which are investments in
factories, real estate, etc., has exploded in recent years, from $47.4 billion
in 1994, to $316.5 in 2000. This is real
proof that foreign investors are taking a big stake in the U.S. economy.
Between 1997 and 1999, they quadrupled to $282.9 billion.
A couple of deals that highlight the Great American Sell-A-Thon include:
Daimler-Chrysler and Deutsche-Telekom/VoiceStream.
This might mean
that the competitive advantages that the U.S. now enjoys in these industries
will narrow more quickly than many expect, especially now that the U.S. economy
is slowing.
This is
cutting into gains made in recent years by U.S. multinationals, as more and more
foreign companies get a piece of the U.S. economy.
The weakness in the U.S. economy and the correction in the U.S. dollar
could provide foreign investors with a rational basis for shifting from
accumulation of U.S. assets to liquidation.
After
all, can you imagine a central bank, such as the German Bundesbank, opting to
invest public money in corporations of any country but their own? Therefore, over
time, dollar reserves are likely to shift to either euro or yen reserves, where
large, liquid government debt markets will remain in place for years to come.
yes”> There is great risk, however, that foreign investors could pull the
rug out from U.S. investors during periods when they sour on the relative
opportunities here.
In the
long run, however, the numerous forces that have enabled the U.S. to outgrow
most of the industrialized world for so long will almost certainly stymie any
sustained period of liquidation.
yes”> as we all witnessed during the Global Financial Crisis of
1998, capital can flow fast and furiously at the click of a mouse.
Investors should therefore be mindful of the powerful influence that
shifting global capital flows can exert upon U.S. markets, especially with
foreign holdings of U.S. assets now at unprecedented levels.
The risk is that for short but decisive periods, foreign investors can
exert more influence upon U.S. markets than any other factor.