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While the surge in U.S. stocks has gotten all the attention, there are also potential opportunities in international markets such as Japan and Europe. Money Talk Live's Greg Bonnell speaks with Michael Brown, vice president, director and co-leader of fundamental equity research at TD Asset Management.
Transcript
Greg Bonnell – While the surge in U.S. stocks has gotten all the attention, there are potential opportunities in international markets as well. Joining me for today's discussion is Michael Brown, vice president, director and co-leader of fundamental equity research at TD Asset Management. Michael, welcome to the show.
This isn't your first time in the studio, you know. I've chatted here before, but this time I'm here to chat with you, the viewers. I'm glad you're here.
MICHAEL BROWN: Okay, thank you so much for having me.
Since this is your first time on the show, let's talk a little bit about your role and areas of expertise at TD Asset Management.
Michael Brown – Well, he's the co-head of research and a PM in a couple of different capacities, specializing in international equities.
Greg Bonnell – International equities is obviously an area that we don't think about a lot, but we probably should.
Michael Brown: Yes, basically everything outside of North America, so Europe, Japan, Australia, emerging markets.
Canadian investors are often criticized for being too country-centric. However, I think that most investors in the world are very country-centric. So, speaking internationally, what is the situation of international investment? What is the current situation?
Michael Brown – First of all, as we all know, the U.S. market has been doing very well for many years. If you look outside of North America, particularly Japan and Europe, you've seen positive changes there as well, and valuations are pretty reasonable relative to the U.S. and relative to history. So we measure it with the earnings risk premium, which is basically a sophisticated way of comparing stocks and bonds.
We also feel there are attractive valuations outside the U.S. and are looking to diversify into sectors. Obviously, we know the U.S. is dominated by the large information technology industry. And then, as we look outside the U.S., there are other areas in Europe and Japan that can offer us more diversification than we can get in North America.
Greg Bonnell – You talk about valuations, and I think that's really interesting given the current state of technology concentration in the U.S. I wonder if some are concerned that, when you look at the portfolio as a whole, because the U.S. is so dependent on technology, there must be opportunities elsewhere?
Michael Brown: I think that makes sense. Diversification over the long term has proven benefits.
Greg Bonnell – Okay. So when we talk about international investing, let's break down a few areas. I'm sure you've got a few in mind. Let's start with focus. What do I mean by focus?
Michael Brown – In the US market, the tech Mag Seven dominates market performance, which is slang for “less than 20% of the top 10 stocks in the international market,” meaning you have a wide range of stocks that you won't find anywhere else and there is certainly an opportunity to get a big position in those stocks.
While some of the outside leaders are in many ways forgotten about the auto industry, there are also other strong auto stocks trading at similarly deeply discounted valuations that could benefit from a consumer upturn.
There are also areas that are benefiting from Japan's tourism boom, such as within Japan itself. A weaker yen is good for tourists. There are many businesses that benefit from a weaker yen and an increase in tourists to Japan.
Greg Bonnell – That's interesting. You mentioned the valuation gap and opportunity that you see in the North American market, specifically the U.S. Let's dig a little bit deeper into that. What are we talking about? What should investors be keeping in mind if this is one of the metrics that they use to do their research?
Michael Brown – Well, I think you have to look at comparable growth rates, and there are stocks right now that have great growth potential outside of North America, and those often represent an opportunity.
Greg Bonnell – Just to ask you about valuation. We all know the U.S. economy is doing well, the U.S. stock market is doing well. We start comparing that to international markets. What do you see that looks interesting there and represents an opportunity internationally?
Michael Brown: Well, if you look at the strength of the U.S. market, the international market is still in the double digits for one-year earnings, it's historically strong, it looks like it has potential and it looks attractive.
Greg Bonnell – So let's dig in. We touched on this a little bit when we were talking about the big ideas around different parts of the world. Let's dig into what's going on right now in Europe, what's going on economically and how that's impacting corporate profits.
Michael Brown: Similarly, there are signs that the economy is slowing. There's negative sentiment coming out of Germany. But the key is to look at the blue chip companies and blue chip businesses within Europe. A lot of those markets are in the U.S., benefiting from a strong U.S. dollar. And also the overall growth, whether that's in South Asia or other parts of the world.
And some of these European machinery names are focused on return on capital and have outperformed over the long term in terms of relatively good solid businesses, so we're looking at those names. And the other area we're looking at is, you know, interest rate cuts are on the table in the U.S., they're on the table in Europe as well, so we're looking at some companies that will benefit from that.
Greg Bonnell: Europe. Japan has had a very interesting year this year. I think for a long time, not many people were talking about Japan. But over the past year, people have started talking about Japan. Besides tourism, what's going on there? What's going on in the market?
So Japan finally surpassed the 1989 high in June. Needless to say, it was a 30-year recovery, a long period of deflation and negative interest rates. In 2012, Japan, Shinzo Abe, launched what was then called Abenomics, which began with fiscal stimulus, monetary easing, and a weaker yen to benefit exporters.
But there was also, at the time, what was called Shinzo Abe's third arrow, corporate reform, and really improvements. In Japan, because of the deflationary environment of the last 30 years, there are a lot of companies whose balance sheets are largely cash. And what's happened recently, basically in the last year or two, is that a lot of the measures that were proposed as part of Abenomics are starting to become a reality.
That means better allocation on the balance sheet, share buybacks, returning capital to shareholders, selling non-core businesses. If a grocer also owns golf courses, there are limited synergies. That's where we see shareholder-friendly corporate actions. Even the Japan Stock Exchange has developed an index of companies trading below book value as an incentive.
It was colloquially called the “name and shame index,” but they looked at it as a measure of improvement in book value. And primarily balance sheet rationalization, capital allocation was positive. As you know, there has been a significant correction in Japan over the last few weeks.
Greg Bornell: This rate hike appears to have changed some people's thinking about Japan, probably in the short term.
Michael Brown: Exactly. The Bank of Japan has raised interest rates. The Bank of Japan had negative interest rates much earlier than other banks, and now they have officially come out of that period. And the Bank of Japan is the last to come out of that period. And the Bank of Japan has raised interest rates to about 0.25%. This is obviously a big turning point for Japan.
They've been dealing with inflation, mostly import inflation. So food prices have gone up, the cost of living has gone up. I mean, this was probably part of why the Japanese prime minister chose not to run again in September. But at the same time, exporters have benefited. Corporate reforms have been made.* And Canadian investors have benefited because the yen has risen quickly on interest rates because of the weaker currency. So we've seen some recovery since this correction. And the key thing is that earnings growth in yen terms is approaching U.S. levels. And in U.S. dollar terms, it's obviously improved because of the stronger yen. That's a pretty positive picture.
Greg Bonnell – Michael, you make a compelling argument as to why Canadian investors should look outward when sometimes they only look inward. It seems like when Canadian investors look outward, they start thinking about currencies. What do you think we need to keep in mind as international investors?
Michael Brown – In terms of currencies in the portfolio, some portfolios are 100% currency hedged. Usually, investing in other currencies is part of diversification. With the strength of the US market, the US dollar is also getting stronger.
As we all know, currencies are difficult to predict, but having exposure to the Canadian Dollar and US Dollar as well as the Yen, Euro and Australian Dollar provides diversification opportunities.
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