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the long view

It's time for investors to look beyond North America.

Yes, you've heard that message before. But it carries extra urgency in a world where attractive investment opportunities are becoming absurdly rare.

Bonds offer next to no yield. Canadian stocks aren't cheap and face what could be a long-lasting downturn in commodity prices. U.S. stocks have enjoyed a monumental rally but now appear as pricey as they have at any time outside the great bull market peaks of 1929, the dot-com bubble and 2007.

So where can an investor turn? Several stock markets outside North America are significantly cheaper than what's on offer closer to home. Some seem poised to benefit from easy money policies designed to goose economic growth.

Japanese stocks, for instance, should get a boost from continued aggressive monetary easing by the Bank of Japan, according to Julian Jessop of Capital Economics. He predicts the Nikkei benchmark will rise from its current 19,531 to hit 23,000 by the end of 2016.

European stocks also hold potential. The European Central Bank's bond-buying program, which is designed, in part, to lower the value of the euro and goose exports, has injected new life into the continent's equities. Germany's DAX index has surged 16.8 per cent since the start of the year and many other European indexes have also enjoyed double-digit gains.

The rally has been driven in part by the appealing valuations of many European stocks. But the Euro Stoxx 50 index, a benchmark composed of 50 blue-chip European companies, still trades for less than 16 times estimated earnings for the next year, compared with roughly 19 times for Canada's S&P/TSX Composite.

The case for foreign investing grows even stronger if you look at countries in terms of their stock prices compared with their corporate earnings over the past decade, a measure that has had some success in predicting long-term returns.

This so-called cyclically adjusted price-to-earnings (CAPE) ratio indicates the stocks of several emerging countries, such as Brazil, Poland and Russia, are less than half as expensive as their U.S. counterparts and at least 25 per cent cheaper than their Canadian equivalents. Several developed countries, such as Britain, Spain and Italy, also look like bargains.

To be sure, many of these markets are volatile and exposed to possible calamities, such as a Greek exit from the euro zone. However, in the eyes of some experts, they hold more potential than Wall Street over the next few years.

"Our expectation is that the S&P 500 will struggle to make further headway over the next couple of years despite the health of the U.S. economy, as the strengthening dollar and labour market at home begin to squeeze profit margins," says John Higgins of Capital Economics.

Jeremy Grantham, the plain-spoken co-founder of money manager GMO in Boston, offered an even darker viewpoint in his quarterly letter last week.

Mr. Grantham, who has had an enviable track record of forecasting relative returns, predicts that U.S. large-cap stocks will lose an average of 2 per cent a year in after-inflation terms between now and 2022, while U.S. small-cap stocks will wither away at a 3.2-per-cent annual pace.

By comparison, Mr. Grantham thinks international stocks will break more or less even in real terms, while emerging market stocks will generate modest annual gains.

All of this suggests that devoting a portion of your portfolio to assets such as European or emerging market stocks would be a sound strategy – not because they will necessarily generate huge profits, but as a hedge against a serious downturn in North American equities.

Remember, though: This is a strategy for the next several years, not next week. Mr. Grantham acknowledges "that in our strange, manipulated world, as long as the Fed is on the side of a strong market there is considerable hope for the bulls."

He figures the S&P 500, which now hovers around 2,100, will have to hit 2,250 before it is in full-fledged bubble territory and could easily extend its winning ways through the U.S. presidential election in 2016.

"But foreign markets are … to be preferred if you believe our numbers," he concludes.

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