International Outlook: Think All the Best Stocks Are in the U.S.? Think Again.
A decade of dominance by U.S. stocks raises a common question: Why bother investing outside the 50 states?
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 investors who ignored European, Asian and other non-U.S. stocks would have missed many of the best opportunities.
For long-term investors, international markets present a fertile hunting ground. In addition to diversification, non-U.S. stocks offer a number of 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, a Capital Group 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.
The European discount
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 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 and Kering (Think Louis Vuitton, Fendi and Gucci.)
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 and Taiwan Semiconductor, to name a couple.
“In some places, the economy may not be thriving but you can still find companies that are thriving,” says Jody Jonsson, a Capital Group portfolio manager. “As a global manager, I want to own companies that are truly excellent in their respective industries, regardless of where they are headquartered.”
The long-term outlook for international equities is clouded by a slowing global economy, heightened trade tensions and rising political uncertainty, says Andrew Suzman, a Capital Group portfolio manager. Ongoing trade disputes could further complicate the outlook going forward — but 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.”
Posted June 13, 2019.