Volatility 2020: Election watch and Washington update
October 2, 2020
Capital Group video transcript: “Consider a ‘best companies’ approach to global investing”
Will McKenna: Rob, there's almost this conundrum of eight out of the last 10 years the U.S. market did better, but this year 45 of the top 50 stocks were outside the U.S. How can that be?
And then I know you also focus a lot on the composition of the index in the U.S. versus outside, and the fact that those indexes kind of mask what's really happening underneath. Talk a little bit more about that whole concept and help our audience understand how should they be thinking about that in today's world?
Rob Lovelace: I think the conundrum that you highlight really well is the conversation usually starts with how impressive what's going on in the U.S. is. The companies that are here that are really unique, particularly in the tech space, somewhat in the biotech and/or health care areas in particular, and those are the ones really driving growth. And the U.S. has done better eight of the last 10 years. The compounding since the great financial crisis has really been remarkable. So why would you invest anywhere else? Thirty percent of the revenue of U.S. companies comes from outside the U.S. Why wouldn't we just consider the S&P a great global fund to invest in?
And I think maybe that's the first piece that begins to show you the flaw in the logic, which is: OK, 30% of the revenue comes from outside the U.S., but that's a really badly constructed global strategy. Right?
Will McKenna: Right.
Rob Lovelace: I mean, wouldn't you rather buy the best companies than just say, “Oh, great. I'm getting some U.S. companies that do business outside the U.S.” And a lot of that non-U.S. exposure actually comes from supply chain as opposed to it being the Coca-Colas or others that really have real revenue outside of the U.S. So why don’t we look for the best companies around the world?
And again, we've got a slide that shows over the last 10 years, a majority of the stocks in any given year that did better were based outside the U.S. And a lot of times, it's because they do business in the U.S. So a lot of the consumer products companies, a lot of the luxury companies and other companies that have done well are domiciled outside the U.S.
So the great thing that we've noticed is we don't care as much about ZIP code anymore. Where a company gets its mail is not a good proxy anymore for where they do business. You really need to get in on the fundamentals and think about where companies are doing business. And some of the best businesses to get exposure to growth in China are domiciled in Europe. Some of them are domiciled in the U.S. And some of the ways to get at things that are happening in the U.S. are actually domiciled outside of the U.S.
So you really want to just focus on the best companies, wherever they're based. Because of this construct that we've had for so long of U.S. versus non-U.S., we tend to have regression-to-the-mean kind of an approach and think, "Well, the U.S. has done well, so non-U.S. necessarily will catch up.” I have a hard time arguing that, because the difference in the multiples — forward P/E of about 17 in the U.S. and maybe 13 and change outside the U.S. — is mostly explained by structural differences in the index.
Outside the U.S., the index is dominated by financials and commodities and materials companies, mainly oil companies. The U.S. is dominated by the internet, technology and health care.
Will McKenna: So, old economy outside and new economy inside of the U.S.?
Rob Lovelace: Right, and when you correct for those two, the multiples are actually pretty similar. So what it tells you is that actually, everyone's doing their job. And when you have a fast-growing company like ASML that's based in Europe, guess what? It trades at the same multiple as the other technology equipment providers. So you have to change the mindset of U.S. versus non-U.S. to find the best companies wherever they're based. Make sure you're finding someone that's doing that analysis, because why would I limit my universe to one third of the companies arbitrarily because they happen to have decided to be domiciled in the U.S.? Why not invest in great companies that happen to be based in Japan, that happen to be based in China, that happen to be based in Germany? And this is why the conversation around what's happening with the German economy or what do I think of Brexit almost becomes moot. It's not what matters anymore. What matters is where the companies are doing business, what business lines that they're in, and are they able to grow in this tough environment.
And we're finding as many or more opportunities outside the U.S. than the U.S., even though I think overall, the U.S. market will be one of the best markets going forward. So that's a conundrum, but the reality of it is, if you can find those great stocks based outside the U.S., you'll do even better than the U.S. market.
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