International Stocks: What Do Earnings, Quality and Valuation Tell Us?
Despite a mixed macro view, global opportunities can be found through bottom-up analysis
As we look toward 2017, the general near-term outlook for international equities continues to appear somewhat mixed, given a combination of global macroeconomic risks. In our view, some of the larger risks include possible instability relating to Brexit and the eurozone, deleveraging in the largest emerging markets, and uncertainty created by the recent US presidential election as well as upcoming elections in Germany and France.
But no matter if the equity outlook is positive, negative or mixed, the Invesco International and Global Growth team takes a bottom-up view of investment opportunities — assessing companies by their Earnings, Quality and Valuation (EQV) characteristics. Below, I discuss the trends that we’re seeing, and how those look through our EQV lens.
Developed markets: A ‘lower for longer’ approach to interest rates
In the US, the Federal Reserve has reduced its outlook for future interest rate increases in 2017 and 2018, indicating that rates will remain lower for longer. In Europe, the European Central Bank has kept its stimulus program unchanged, a signal that that policymakers don’t see an immediate risk to recovery in the region. And in Japan — amidst the backdrop of falling inflation, rising long-term bond yields and appreciating yen — the Bank of Japan unveiled new monetary tools in September, deciding to keep long-term rates near 0% and inflation about 2%.
Emerging markets: Slower growth on the horizon?
The expectation that US interest rates would likely stay lower for longer helped to improve investor sentiment in emerging markets in 2016. Firming commodity prices helped as well. However, some of the larger emerging market economies, such as China and Brazil, are in need of an extended period of de-leveraging, in our view. This process would likely trim their growth rates going forward, and thus keep commodity prices more subdued.
Slower growth in China would also act as a headwind to many smaller East Asian economies that are more heavily dependent on exports to that country. As a result, many of these emerging economies may remain highly dependent on a continuing US recovery for incremental growth in the year ahead. This challenging economic backdrop may bring ongoing volatility and stock market dislocations, thus providing more attractive buying opportunities for long-term investors like ourselves.
Regardless of the macroeconomic environment, the team remains focused on applying our EQV investment process that seeks to identify attractively valued, high-quality growth companies.
Earnings. The difficult earnings environment we’ve experienced in the last few years started to improve during 2016, as the pace of global earnings-per-share downgrades slowed. While we still saw negative revisions in Japan, Asia ex-Japan and emerging markets toward the end of the year, the US and Europe experienced upgrades in both earnings and sales. Given the heavy export focus, many Japanese companies have suffered from the yen appreciation. Asia ex-Japan has been impacted by strength of the US dollar as a number of Asian currencies closely track the US dollar.
The net earnings upgrades in Europe are the first since 2010. They’re primarily driven by the UK, where the weakening currency is the main driver, but we’re also seeing positive revisions in Switzerland, Germany and Spain. Whether or not this will continue is difficult to tell, but currency-driven revisions are typically short-lived and most likely need improving economic fundamentals to be sustainable.
Our team is often asked whether we hedge currencies. We don’t hedge our currency exposure in any of our strategies for four main reasons:
- While foreign currency exposure introduces some volatility over the short term, we don’t believe it has a significant impact on long-term performance.
- In our view, one of the key benefits international funds can provide US-based investors is to lower correlations to the US market. Hedging currency exposure increases the correlation, thereby lowering the diversification benefit.
- Currency hedging is also redundant to a large degree because many foreign companies have global operations with exposure to many different currencies, and they often hedge their own currency exposure directly.
- Finally, hedging is costly and can introduce unwanted leverage to a portfolio.
Quality. Companies’ return on equity (ROE) has been trending down since 2012 on a global basis and is showing no signs of improving. Improvement is unlikely to happen before we get a top-line recovery. Having said that, the strategies managed by the Invesco International and Global Growth team all have ROEs that are about 5% to 10% higher than their respective benchmark indexes.
Valuation. Because markets are up and earnings are down to flat, most regional valuations rose during 2016. Overall valuation levels in developed markets continued to appear full despite the high macro risk and challenging outlook for the earnings growth in the year ahead.
If you look at valuation dispersion as a way of indicating where you might find opportunities, emerging markets look most attractive — although less so than in the beginning of 2016, due to the strong bounce in emerging markets — and the US looks the least attractive.
Data as of Sept. 30, 2016, unless otherwise specified.
Clas G. Olsson
Senior Portfolio Manager, Managing Director
CIO, International Growth Equity
Clas Olsson is Chief Investment Officer (CIO) and Senior Portfolio Manager with the Invesco International and Global Growth team. He also serves as a lead manager on the Invesco International Growth and Invesco European Growth strategies.
Mr. Olsson began his investment management career in 1994 as an investment officer and portfolio analyst specializing in international equities with Invesco. He was promoted to portfolio manager in 1997 and assumed his current role as senior portfolio manager in 1999 and CIO in 2009. Prior to joining Invesco, Mr. Olsson was a communications officer in the Royal Swedish Navy.
A native of Vasteras, Sweden, Mr. Olsson became a commissioned naval officer at the Royal Swedish Naval Academy in 1988 and earned a BBA degree in 1994 from The University of Texas at Austin.
The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.
The performance of an investment concentrated in issuers of a certain region or country is expected to be closely tied to conditions within that region and to be more volatile than more geographically diversified investments.
Many countries in the European Union are susceptible to high economic risks associated with high levels of debt, notably due to investments in sovereign debts of European countries such as Greece, Italy and Spain.
The information provided is for educational purposes only and does not constitute a recommendation of the suitability of any investment strategy for a particular investor. Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state tax laws are complex and constantly changing. Investors should always consult their own legal or tax professional for information concerning their individual situation. The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.
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