Think global, invest globally

NEW YORK (Reuters) - In terms of the U.S. economy's relationship with the rest of the world, the tail may now be wagging the dog.

And investors should sit up and take notice.

The United States' traditional role as the engine of the global economy is changing profoundly as developing countries like China and India become more of an influence on supply chains, resources and financial markets.

Industrialized economies outside of the United States, particularly in Europe, in the last few years have become more productive and financial markets more liquid.

While still the biggest in the world, the U.S. economy's influence is no longer the only one that counts and this will continue to affect capital flows, exchange rates and investment decisions, said analysts at the Reuters Investment Outlook Summit this week in New York.

Over the longer term, U.S. investors can earn better returns at lower risk by sending more of their savings overseas.

"We think U.S. investors are still very much underdiversified in their foreign exposure," said Brian Garvey, senior strategist with State Street Global Markets.

U.S. pension funds, which have long-term investment views based on economic themes, on average have 20 percent of their portfolios dedicated to foreign assets, but the optimal exposure is more like 65 percent, Garvey said.

Last year, U.S. investors bought a record $246 billion in foreign stocks and bonds, which was perhaps unsurprising given the relatively high rate of return on many overseas markets.

The Standard & Poor's 500 Index .SPX of U.S. stocks has risen 32.5 percent since 2001, while the Morgan Stanley Capital International global stock index grew almost twice as much, at 60 percent.

Further sweetening the deal, the dollar has declined around 30 percent over the same period against a basket of major currencies .DXY, massively inflating the returns to U.S.-based investors from buying foreign stocks.

A DOWNWARD SLOPING LINE

Louise Yamada, market technician at Louise Yamada Technical Research Advisors, pointed to a chart of the MSCI U.S. stocks index against the all-country world equities index, running her finger across a downward sloping line that began falling since 2004.

"The U.S. has underperformed the world ... we have never seen that before," she said.

Even skeptics of the theory on how the U.S. economic cycle of boom and bust is becoming unwound from the cycles of other major economies -- a phenomenon referred to as decoupling -- say the attraction of investing overseas has been unmistakable.

Abhijit Chakraborti, global equity strategist with JPMorgan Chase, noted that since 2004 European equities have outperformed the United States by 38 percent in local currency, which he said he found amazing given the euro's EUR= march to record highs against the dollar this year.

"If you have been underweighted Europe relative to the United States for the last three and a half years you're not going to be retiring for a while," he said.

One of the reasons for the urge among U.S. investors to find higher yielding and higher risk assets overseas is the low financial market volatility. Such an environment has made currency carry trades, in which investors borrow cheaply in a low-yielding currency such as the yen to buy a higher-yielding asset, especially popular.

A powerful 60 basis point rise in the benchmark 10-year Treasury note yield in the last six weeks, which has outpaced the rise in other government bond yields, has so far not been enough to bring U.S. investors back home.

"It's not so much U.S. yields anymore that really dominate and drive the whole carry idea. It's the yield spreads between high yielders and low yielders," said Mike Moran, senior foreign exchange strategist with Standard Chartered.

In perhaps the most telling of indicators, none of the analysts at the Reuters Investment Outlook Summit predicted a near-term end to the carry trade or to the flow of U.S. investor money overseas.

Going global, it seems, is here to stay.

"What's wrong with a world that's growing as rapidly as we've seen?" said Jack Malvey, chief global fixed income strategist with Lehman Brothers.

"Be careful of trying to change this formula."