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The run in U.S. equities have grabbed all the headlines, but there is also potential opportunity in international markets like Japan and Europe. MoneyTalk Live’s Greg Bonnell discusses with Michael Brown, VP, Director & Co-Lead of Fundamental Equity Research at TD Asset Management.
Transcript
Greg Bonnell – The run in US equities has been grabbing all the headlines, but there’s also potential opportunity in the international markets. Joining us now to discuss is Michael Brown, VP, Director, and Co-Lead of Fundamental Equity Research at TD Asset Management. Michael, welcome to the program.
It’s not your first time in the studio, I know. We’ve chatted here before, but now we’re chatting for our audience. Great to have you here.
Michael Brown – Yeah, thank you for having me.
Let’s talk a little bit, since this is your first time on the show, your role at TD Asset Management and your coverage area.
Michael Brown – Well, co-head of research, and then specializing in international equities as PM on a couple of different mandates.
Greg Bonnell – So international equities, obviously, this is a space that we don’t think about a lot, but we should be thinking of, perhaps.
Michael Brown – Yeah. So it would be, essentially, everything outside North America– so Europe, Japan, Australia, emerging markets.
Canadian investors are often, I guess, criticized somewhat for the fact that we’re a little too home country. But I think a lot of investors out there, they’re very home country-centric. So if we’re talking about international stuff, what is the case for international investing? What does that climate look like right now?
Michael Brown – Well, first and foremost, as we all know, the US market has been extremely strong for years. Looking outside of North America, particularly in terms of Japan and Europe, there are positive changes there as well and then quite reasonable valuations relative to the US and relative to history. So we would measure that on an earnings risk premium, which is, basically, a fancy method of equities versus bonds.
And we do feel that there’s attractive valuations outside of the US, as well as looking at sector diversification. Obviously, we know that the US is dominated by the large information technology industry. And then looking outside, there are areas in Europe and Japan, not as well, that would offer additional diversification beyond what you would get in North America.
Greg Bonnell – You talk about valuations. I think this is pretty interesting considering the run that we’ve seen heavily concentrated in tech in the United States. If you’re taking a look at a portfolio on a holistic basis, does that give some people concern to say the US is so levered to tech that surely there must be opportunities elsewhere?
Michael Brown – I think that does make sense. Diversification over time, over the long cycle, has proven to have benefits.
Greg Bonnell – All right. So when we talk about international investing, let’s start breaking down some of the buckets. I know you have some in mind. We’re going to start with a concentration. What do we mean by this?
Michael Brown – In terms of the US market where you see the tech, the Mag Seven, it’s a colloquial term, dominating market performance– the top 10 holdings within international markets is less than 20%. So it does offer opportunities where you could have a wide variety of names and significant positioning in those names that you would not see elsewhere.
Amongst those names leading outside, people have forgotten the auto industry, in a lot of ways, but there are auto names that are doing well maintaining and then trading similar, very discounted valuations with potential for a turn in consumer.
As well, there’s also other areas, like within Japan, benefiting from the tourist boom in Japan. The weak yen is good for tourists. There’s lots of businesses that benefit from that weak yen and then also increased traffic into Japan.
Greg Bonnell – Interesting stuff there. You mentioned the valuation gap in terms of what we’ve seen in the North American market, particularly United States and the opportunity. Let’s dig a little bit deeper into that. What are we talking? What should investors keep in mind if this was one of the metrics they’re using to do their research?
Michael Brown – Well, I think you’d have to look at the comparable growth. And currently, there are names that offer strong growth outside of North America as well. And those represents, frequently, opportunities.
Greg Bonnell – Just on the valuation side. We all know about the outperformance of the US economy, the performance of the US stock market– we start comparing it to those international markets. What are you looking at there that looks interesting and then speaks of opportunity internationally?
Michael Brown – Yeah. You think about the strength in the US market, the one-year returns on international markets is still double-digit. It’s strong relative to history, and it is looking attractive with potential.
Greg Bonnell – So let’s start to dig– we’ve mentioned briefly there, as we were talking about some of those bigger ideas about different regions of the world. Let’s dig into what’s happening in Europe right now, economically and then how that plays to corporate profits.
Michael Brown – Similar, there’s indications like the economy is slowing. There’s been some negative sentiment out of Germany. But the key is focusing on good companies within Europe and good businesses, where a lot of their markets, some are US, benefiting from the strong dollar in the US, as well as broader growth throughout, whether it be South Asia or other regions of the world.
And some of these European machinery names, the focus on return on capital, they have been long-term outperformers in terms of relative just good solid businesses, so looking to those names. And other areas where we’ve been looking– as you know, rate cuts are on the table in the US. They’re also on the table in Europe as well, so looking at some beneficiaries of those as well.
Greg Bonnell – That’s Europe. Japan’s been very interesting this year. I think for the longest time, not a lot of people were talking about Japan. They’ve been talking about Japan over the past year. On top of the tourism, what’s going on there? What’s going on with the markets?
So Japan finally broke its 1989 high in June. Obviously, it’s been 30 years of recovery– well, significant period of deflation, negative interest rates. Back in 2012, Japan, Shinzo Abe, initiated a program called Abenomics at the time. And it started with fiscal stimulus, monetary easing, weakening the yen to benefit exporters.
But there was also at that time, they called it Shinzo Abe’s third arrow, which was the corporate reform and, actually, improvements. With the deflationary environment to the last 30 years in Japan, you have a lot of companies that, essentially, their balance sheets are largely cash. And what’s happened recently, basically over the last year or two, is a lot of those measures that were suggested as part of Abenomics have been coming into fact.
And that is better allocation on the balance sheet, share buybacks, capital return to shareholders, divesting of non-core business. When you have a grocery store that also owns a golf course, the synergies are limited. And so that is what you’re seeing some corporate action there that’s favoring to shareholders. And even the Japan exchange developed an index of companies trading below book value as an incentive.
The colloquial term was the “Name and Shame Index,” but they took it as a measure of improving the book value. And, largely, balance sheet rationalization, capital allocation, that’s been positive. As you know, there was a significant correction within the last couple of weeks in Japan.
Greg Bonnell – That rate hike seemed to have changed, perhaps in the short-term, some people’s ideas of Japan.
Michael Brown – Correct. So they did increase rates. They are now officially out of the negative interest rate period, which they entered long before anyone else. And they are the last ones to exit it. And they raised their interest rates to 0.25%, roughly, which is, obviously, a game-changer in Japan.
They have been dealing with inflation, largely imported inflation– so cost of food has gone up, cost of living has gone up. I mean, that would have been part of the case for the Japan prime minister choosing not to run again in September. But at the same time, the exporters have been benefiting. There’s been corporate reforms. * And also, with the currency weakness, Canadian investors would have benefited as the yen strengthened very rapidly with the rate hikes. So since that correction, we have seen somewhat recovery post. And the key is earnings growth measured in yen is approaching US levels. And in US dollars, it’s improved, because, obviously, with the yen strengthening. And it’s a pretty positive case there.
Greg Bonnell – So, Michael, you have some compelling arguments as to why Canadian investors, who sometimes only look inward, should be looking outward. Sometimes I feel like when a Canadian investor is looking outward they start thinking about currency considerations. What do you need to keep in mind as an international investor?
Michael Brown – In terms of currency in the portfolio, there are portfolios out there that are 100% currency hedge. Typically, investing in other currencies is part of the diversification. Along with the US market strength, there has been strength in the US dollar.
Predicting currencies is a challenge, as we all know. But it does provide opportunities for diversification beyond Canadian dollar exposure, US dollar exposure, to have yen, or euros, or Australian dollars as well.
