Markets Apr 30

5 themes that are underestimated by international equities investors 

Five global trends have the potential to shape the direction of markets — China, Japan, technology, value and the resiliency of international markets — may provide distinct opportunities, Justin Thomson, Head of International Equities at T Rowe Price, says

by Justin Thomson
5 themes that are underestimated by international equities investors 
Image: Reuters.

(ATF) There five global trends that international investors appear to be underestimating which have the potential to shape the direction of markets. These areas of focus — China, Japan, technology, value, and the resiliency of international markets — may provide distinct opportunities as investors seek to shape portfolios in the wake of the coronavirus pandemic.

1. Investors still slow off the mark in China

The rapid rise of China to the world’s second‑largest economy is widely observed. Yet, investors appear to underappreciate China’s opportunity to continue expanding. Gaining exposure to China by simply aligning to its growing representation in global indexes means investors risk missing out on much of the country’s potential. 

There has been growth in listed equities in China across a range of sectors, representing an impressive universe of companies for alpha‑seeking investors to explore. Those willing to explore could discover the lesser known opportunities with the potential to compound over time and generate real value.

For example, we see a group of 51 outlier stocks within the market that compounded by over 20% per annum over the 10 years to November 2020, cumulatively far in excess of the gain of the broader CSI 300 Index and matching the trajectory of the market’s leading tech performer over the period (Financial data and analytics provider FactSet, 2021).

China’s macroeconomic and market dynamics are set to continue, and yet many investors are under‑indexed to Chinese securities. In our view, investors can do more to uncover the alpha potential of China’s growing and diverse market as a potential feature of their international equity portfolios. 

2. Japan’s gains are by design, not chance

For many investors, the popular narrative since has been to associate the Japanese economy with perennially low growth and inflation and an economy lumbered with a poor demographic profile due to its aging and falling population. 

Less appreciated, however, is that Japan has been the best‑performing major developed equity market over the past 10 years outside the US (based on a comparison of performance of major developed markets in the MSCI World Index: FactSet Research Systems). 

Performance has been bolstered by orchestrated, long‑term structural changes in company governance and levels of foreign investment, alongside a decrease in domestic cross‑ownership. The impact has been to underpin improvements in company earnings profiles that have seen Japanese equities successfully break from a low‑return past and converge with the profitability levels of global peers. 

The renowned might and efficiency of Japan’s industrial production is now accompanied by encouraging improvements in capital and balance sheet management. These are manifested in changes to patterns of capital allocation — with the combination of dividends and buybacks having increased over time, bolstering potential returns for equity investors. These changes are set to be powerful drivers of equities over the next cycle. 

As a result, we believe there are potential opportunities for investors in a strategic allocation to Japanese equities. 

3. The tech story knows no borders

The coronavirus pandemic has served to accelerate the rise of some technology platforms in retail, social media, streaming content and remote conferencing. It has served to further expose the divide between industries and companies benefiting from disruption and those challenged by it.

Although big‑name US tech stocks have tended to dominate the headlines and investor enthusiasm, innovation and disruption are not the preserve of the US. Disruptive technology companies have grown to represent 50% of the MSCI China Index and 40% of the MSCI Emerging Markets Index (calculations using data from FactSet Research Systems), providing an abundant source of opportunity for investors seeking exposure to these trends. 

The upshot for investors looking to take advantage of ongoing disruptive trends is that innovation is shaping international markets, not just the US. A global investment lens is essential in seeking to fully capture the multitude of opportunities this represents. 

4. Value is back, particularly in Emerging Markets

Prior to the pandemic, “growth” as a factor had already been in the ascendency for a long time — this was then extended by the acceleration of disruptive forces brought about by the pandemic. Now, signs of improving macroeconomic conditions, massive fiscal measures by governments of major economies, ongoing monetary stimulus, a cyclical rebound in oil prices, an uptick in inflation, and a steepening yield curve provide a compelling backdrop for a recovery in value stocks. 

With markets currently elevated, relative prices look increasingly favourable for value‑orientated areas of the market. Specifically, stock‑specific valuation multiples have widened, creating a much better backdrop for value stock pickers. It remains important, however, to distinguish between companies that are cyclically depressed and those that have more underlying long‑term structural concerns. 

We believe Emerging Markets provide a particular opportunity, with currencies undervalued and a relatively high exposures to cyclical sectors providing potentially good opportunities for investors seeking to benefit from the “value” play. 

5. International markets are poised to gain the ascendency

Factors that have previously favoured the US equity market, such as a low‑rate environment, are likely to come under pressure. A post‑pandemic recovery in growth, fueled by consumer confidence and massive fiscal spending, is likely to feed through to inflation expectations. That would eventually drive policy rates higher and weigh on sectors that have benefited from historically low rates. Further, the potential for value stocks to return to favour may limit the advantage that the growth cycle for US equities. 

Meanwhile, a weaker US dollar may benefit international returns. The dollar has weakened against every other G‑10 currency since April 2020. An end to the era of US exceptionalism in terms of higher real interest rates, higher nominal and real growth rates coupled with a now abundant supply of dollars could lead to a period of sustained weakness for the dollar. 

Ultimately, if the tide does turn against the trend of US equity outperformance versus international, investors could pivot allocations to try to catch the wave, generating additional momentum for international equities.

# By Justin Thomson, CIO and Head of International Equities at T. Rowe Price


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Investment markets equities T Rowe Price China japan Tech Value resilient markets