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7 Safe Overseas Dividend Plays

December 29, 2011 – by Richard Band

If you had any money riding on overseas stock markets, chances are you’ve taken some pretty nasty lumps this year. Through mid-December, the broadest measure of developed foreign markets — the MSCI Europe, Australasia and Far East Index — has lost 17.8% in dollar terms (excluding dividends). The emerging bourses, according to MSCI, have fared even worse, skidding 21.5%. Painful indeed, especially when you consider that the headline U.S. stock indices are at either slightly above (Dow Jones industrials) or slightly below (S&P 500) the breakeven line.

So the question arises: Does it still make sense to diversify internationally?

Tempting as it is to be cynical about a financial world that often seems broken, I don’t think we’ve seen the end of great profit-making opportunities in foreign markets. In fact, the recent weakness in overseas stocks probably is setting us up for exceptional returns once the current distress passes. The main reason, of course, is valuation. As of Dec. 14, according to Bloomberg, the stocks comprising the Stoxx Europe 600 Index were quoted at a slender 10.1 times estimated 2011 earnings, versus 12.2 times for the Standard & Poor’s 500 Index — a discount of 17%. The MSCI Asia Pacific Index, which normally trades at a sizable premium to the S&P because of Asia’s superior economic growth, was at 12.6 times estimated 2011 earnings.

Some emerging markets are even cheaper. Brazil, for instance, is selling for about eight times trailing 12 months’ earnings, and India about 12 times — both well below their norms for the past five years. Remember too, that, despite a recent slowdown, these countries still are growing much faster than the developed economies of North America or Europe.

For the opening months of 2012, I’m taking a cautious view of most foreign stock markets. Europe’s sovereign-debt travails will weigh on economic activity around the world, but especially in the EU homeland. In addition, we’re picking up early signs that China’s credit-fueled boom might be due for a setback in 2012. Chinese purchasing managers report that the country’s manufacturing sector is now contracting at the steepest rate since early 2009.

Look to Switzerland, Australia for Powerful Long-Term Growth

When the global economy eventually finds its footing, these bourses will snap back a long way fast. Accordingly, I recommend that you proceed slowly and judiciously with new commitments. In Europe, I advise you to favor recession-resistant health care and consumer-staples names, such as drug maker Novartis (NYSE:NVS) and food processor Nestle (PINK:NSRGY). Not so coincidentally, both companies are based in Switzerland, with its friendly business climate and sound currency. Both stocks also throw off generous dividend yields: 4.2% for NVS, and 3.7% for NSRGY. Dividends typically are paid once a year, in April. Switzerland extracts a 15% withholding tax on dividends remitted to U.S. shareholders, but you can obtain a credit against this tax if you hold the stock in a taxable account (not an IRA).

What to do now: Buy NVS at $58 or less, and NSRGY at $56 or less.

Among the other developed markets, my top choice is Australia. Australian tax law encourages corporations to pay out the lion’s share of their profits in the form of dividends. As a result, most Australian stocks yield considerably more than their U.S. counterparts.

Take Westpac Banking Corp. (NYSE:WBK). Strong and conservatively managed, this Aussie bank has boosted its dividend more than 400%, in dollar terms, during the past 10 years. Current yield: a mouth-watering 7.8%. Dividends are paid semiannually, in July and December. No withholding tax currently imposed on U.S. residents.

For a diversified portfolio of Australian stocks, consider iShares MSCI Australia Index Fund (NYSE:EWA). This exchange-traded fund owns a large slug of financials (44% of the portfolio), but also gives you exposure to Australia’s natural-resources sector. Current yield: 5.1%.

What to do now: Buy WBK at $110 or less, and EWA at $23.50 or less.

Brazil, India: Submerged, But Not Sunk

I’m confident that Brazil and India — my two longtime favorites among the developing bourses — eventually will snap back to their 2011 highs and beyond. Before a lasting turnaround can occur, however, investors will need to get a sense that the growth outlook in these countries is stabilizing.

That will take time. Hence, I suggest dribbling cash into vehicles like iShares MSCI Brazil Index Fund (NYSE:EWZ) and PowerShares India Portfolio (NYSE:PIN) in equal dollar installments over a period of three to six months. Dividend yield: 2.7% for EWZ, and 1.4% for PIN.

What to do now: Buy EWZ at $64 or less, and PIN at $20 or less.

Emerging-Market Bonds: Great Potential Than Stocks

For the immediate future, emerging-market bonds seem to hold greater potential than stocks. Unlike U.S. Treasuries, EM bonds offer worthwhile yields that exceed, in most cases, the dividends you could earn on stocks from the same countries.

I recommend the iShares JPMorgan USD Emerging Markets Bond Fund (NYSE:EMB). Why go with this ETF, as opposed to an open-end mutual fund or a closed-end fund? Because the manager’s discretion is strictly limited. Under the rules of EMB’s investment policy, the fund limits the weights of countries with higher debt outstanding and reallocates excess cash to countries with lower debt outstanding. This “safety valve” protects you against the tendency of an enthusiastic portfolio manager to load up on a risky country’s bonds because they pay a higher yield. Granted, EMB yields less (5%) than some competitors, but the fund is efficiently managed, with a 0.6% annual expense ratio — and you can rest easy over the long haul with Morgan’s emphasis on capital preservation.

What to do now: Buy EMB at $110 or less.