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Things are looking up - A guide to international equities
Did you know that in the calendar year of 2004 the standard global index for Australian superannuation funds, the MSCI AC World (ex-Australia) Accumulation Index, returned 10 per cent? Perhaps pithy when compared with the bonanza 28 per cent return last year from Australian equities but certainly back to longer term trends.
So far this year, global equities market returns have generally struggled and returns have been underwhelming in spite of positive underlying fundamentals.
As active stockpickers, there are five reasons why we are optimistic that global equities will again deliver a longer term mean return for this calendar year.
1. Earnings yield ratio
Forward earnings yield ratio analysis, which compares the expected earnings yield offered by equities versus that offered by bonds, currently gives the upper hand to equities.
Research from Morgan Stanley indicates that global equities will yield an additional 4 per cent to global sovereign bonds, a result which is two standard deviations away from the historical average. This ratio has not been cheaper since 1993. On this historical metric, global equities are extremely attractive relative to bonds.
2. Valuations
Even when the market is tight (and we don’t believe that it currently is), it is still possible to find quality, growing companies that are trading on low valuations. In this market, we see global equities on the whole as reasonably valued, if not cheap.
Why? Firstly, the price to earnings ratio (PE) across global markets is the lowest that it has been since 1991 at 13.9 times. In the US, stocks are trading on an average PE of 16 times and in Europe, 13.5 times.
Asia is particularly showing up as good value. Japanese stocks are trading at a 50 per cent discount to average levels since 1990 with an average PE of 15.9 times. Emerging markets, including Asia (ex Japan), is trading at 9 times, which is a 35 per cent discount to the rest of the world.
3. Company Earnings
Good investing not only looks at underlying valuations but also seeks to identify those companies with strong earnings growth. Once again, we are being surprised at the upside.
Recently released company earnings for the first quarter of 2005 were better than expected and came in spite of increased output costs.
For example, in the US first quater earnings are coming in at 12.6 per cent year on year when the expectation at the start of the year was for 6.8 per cent. Overall, two-thirds of US companies have beaten earnings estimates so far, with a similar trend apparent in both the UK and Europe. In Japan there was also positive news with earnings up 20 per cent in the year ending March 2005.
4. View from the top
Taking a macro view, the global economy is in pretty good shape. Expectations are for steady global growth, estimated at about 3.8 per cent over the next two years.
Such a profile makes sense against the backdrop of easy global monetary policy. Although the USFederal Reserve has begun to unwind some of this, the G3 cash rate (US, UK and Japan) has only risen from a low of 1.3 per cent to 2 per cent and is still well below its long-run level of around 4.5 per cent.
Rich pickings from the individual regions might also be on offer. Asia’s economies are expected to grow at 6.5 per cent this year with Latin America at 4 per cent to 5 per cent. Even in the face of weighty concerns, consensus forecasts estimate that the US economy will grow between 3.5 per cent and 4 per cent.
Having fallen over $10 from March to May this year, the oil price is currently showing up as a positive for the global economy and the inflation outlook.
Moderating prices for commodities, energy and oil in particular, will help to reduce the output costs for global companies and continue to meet and exceed earnings estimates.
5. Attractive industries
Where are the companies that will be able to take advantage of these positive conditions?
The energy sector is an obvious candidate. Robust global economic growth and the China story has led to soaring energy demand and higher crude oil prices. Although the oil price is off from its recent highs, barrel prices of $30 plus are likely for the foreseeable future. Here, we like BP (UK), Conoco Philips (US) and ENI (Europe).
Demographics will favour healthcare and pharmaceutical stocks. Ageing and rates of obesity underpin the longer term case for these sectors. Important for pharmaceutical stocks is a strong research and development pipeline for new medicines. Our current favourites in this sector include GlaxoSmithKline (UK), Pfizer (US) and Novartis (Switzerland).
Clay Carter is Portfolio manager, Global Equities with Perennial
AUTHOR
Mike Taylor
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