ARTICLES JUNE 2019
A decade of dominance by U.S. stocks raises a common question: Why bother investing outside the U.S.?
While it's true that international equities generally have lagged U.S. markets over the past 10 years, the index-based returns that most investors follow don’t tell the whole story. On a company-by-company basis, the picture is significantly different.
Since 2009, the top 50 companies with the best annual returns each year were overwhelmingly based outside the United States. In many of those years, 80% to 90% carried a non-U.S. address. That means if you had decided to ignore European, Asian and other non-U.S. stocks, you would have missed a shot at many of the best opportunities.
In addition to diversification, non-U.S. stocks offer a number of other potentially attractive traits, including higher dividend yields, the chance to benefit from currency tailwinds if a strong U.S. dollar starts to weaken and — perhaps the most compelling attribute — substantially lower valuations.
"Starting-point valuation is a very good predictor of long-term share price returns," notes Carl Kawaja, Capital Group Global Equity FundTM (Canada) portfolio manager. “I think many people have forgotten that valuation is a critically important metric. The U.S. has become a very growth-oriented market and investors are paying a high price for that. Outside the U.S., you can put together a solid portfolio of good companies at just about the lowest average P/E ratio that I’ve ever seen in my career."
International markets generally have a greater concentration of value-oriented stocks in "old economy" sectors, such as financials and basic materials. Consumer staples stocks are also large components in European indexes. Contrast that with the U.S., where technology and consumer tech companies dominate the Standard & Poor’s 500 Composite Index. That alone accounts for much of the decade-long return gap between U.S. and non-U.S. stocks.
Among like-for-like companies, the valuation gap is especially pronounced when looking at multinationals in the U.S. versus Europe. In many cases, companies with similar prospects trade at significant discounts, in part because they carry a European address.
Some of the negative investor sentiment may be attributed to political risks, underscored by the United Kingdom’s Brexit struggles, the rise of populism across Europe and the relative weakness of the eurozone economy, which is growing at roughly half the pace of the U.S. economy. A brewing trade war also doesn’t bode well for Europe’s trade-dependent economy.
However, among many European multinationals, markets within Europe often account for just a small fraction of their global corporate earnings. Moreover, in certain sectors, European companies are among the most dominant players in the world. The luxury goods industry, for instance, is centered in France and Switzerland with companies such as LVMH, Kering and Richemont. (Think Louis Vuitton, Fendi, Gucci and Cartier.)
The world’s largest food company, Nestlé, is based in Switzerland. Big pharma has no shortage of innovative drug companies in Europe, including AstraZeneca, Novartis and Novo Nordisk. Outside Europe, the story remains just as valid. Japan is home to many cutting-edge robotics firms, including Murata and Fanuc. Some of the world’s most successful technology companies are based in Asia: Samsung, Taiwan Semiconductor and SK Hynix, to name a few.
"In some places, the economy may not be thriving but you can still find companies that are thriving," says portfolio manager Jody Jonsson, which has investments all over the world. "As a global manager, I want to own companies that are truly excellent in their respective industries, regardless of where they are headquartered."
One might argue that high valuations in the U.S. are justified, given the meteoric rise of internet giants such as Amazon, Netflix and Alphabet’s Google. But, even so, it's not that hard to find companies with high valuations outside the United States.
Temenos is an enterprise software firm based in Geneva, Switzerland. It specializes in providing customized software programs to financial institutions, including 41 of the world’s top 50 banks. Temenos trades at roughly 40 times earnings, an impressive valuation that would make Silicon Valley proud.
"At that level of valuation, investors are expecting brilliant execution," explains portfolio manager Mark Denning. "In some cases, fast-growing companies in Europe, such as Temenos, are commanding even higher valuations than you’d expect to see in America."
"There just aren’t as many companies in that league," Denning says. "Growth comes at a premium, no matter where you find it."
The long-term outlook for international equities is clouded by a slowing global economy, growing trade tensions and rising political uncertainty, says portfolio manager Andrew Suzman. Ongoing trade disputes could further complicate the outlook going forward — but, like his colleagues, he is finding no shortage of potentially compelling investment opportunities outside the United States.
"Successful investing requires you to look past the ugly headlines," Suzman says. "It comes down to evaluating specific companies on a fundamental basis and having the patience to take a long-term view."