Is your portfolio ready for bad weather?
May 14, 2019
Remy Blaire: The investing landscape can be a complicated one, even for the seasoned investor. Concerns over economic growth and geopolitics, as well as the implications and impact of trade wars, are top of mind. Despite these challenges, it's more important than ever to uncover opportunities and avoid pitfalls. I'm joined by Pedro Marcal, Director of International Equities at Foresters Financial.
Remy Blaire: Pedro, thank you so much for joining me.
Pedro Marcal: Thank you for having me. It's great to be here.
Remy Blaire: Well, first and foremost, let's start out by looking at the current global landscape as well as the accompanying risks and opportunities. Why invest in international equities, and why is now a good time?
Pedro Marcal: Including international equities in your client's portfolios vastly increases the opportunity set for generating profits, and the more opportunities your clients have, potentially the greater return they can achieve. Currently, we're finding great opportunities overseas to invest in, and relative to the US, international markets are cheap on both a P/E and earnings basis.
Pedro Marcal: The global indices were really formed in the early 1970s, so we have about 50 year’s worth of performance data on them. Surprisingly, in the last half century the US has never been, never been the best performing stock market on a calendar year basis. In fact, if you look at it on a three-year or a five-year basis, the US still hasn't been the best performing market. And so, what are these market indices, but collections of stocks of companies in these countries? So, over the last 50 years, there's always been one market with hundreds of companies and usually more than one, so thousands of companies that have outperformed the US market. And we're simply saying that we think our customers should be investing in international markets so they can get exposure to some of these companies that are growing their earnings and benefiting from change.
Pedro Marcal: And these markets are cheap. They're inexpensive on valuation relative to the US. If you look at the developed markets, they're trading at 13 times or 13-and-a-half times forward earnings. The US market is trading at about 17-and-a-half times forward earnings. So that's four points cheaper. The major markets of Germany in Japan are trading at 12.6, 12.7 times forward earnings, and emerging markets are cheaper still. They're trading at 12.2 times forward earnings. So, we're finding a lot of opportunities there, and these markets are really cheap.
Pedro Marcal: But for me, as a portfolio manager, what's really important is that there are just so many companies that we're identifying as good investments and at these valuations, and these are companies that are growing their earnings and benefiting from change.
Remy Blaire: And Pedro, there has been so much focus on how the major US equities have been hitting record highs, but I think you shed light on the differences between US indices and international indices. So that leads me to my question. Tell me why investors should consider your team.
Pedro Marcal: Really, the only constant in the world is continual change. And our team has designed an investment process that focuses on investing in companies that are growing their earnings and benefiting from change. And we have two philosophical beliefs. One is that higher earnings lead to higher stock prices, and the second is that markets are inefficient, and only one of these inefficiencies is how they recognize and price change. So, we believe the best investments are companies that are undergoing positive change and growing, and they're undergoing change at the company level as well as in their environment. Let me give you an example of the company level. It could be a new product cycle or it could be a new management team or some innovative new technology. In the environment, it can be a new government or regulatory change or could be as simple as more demand for their product.
Pedro Marcal: So once we've identified that there's a change at the company level, we then do our own research to determine whether that change is sustainable, whether there is a strong business model. And you can think about it as whether there is a moat around the company, so something that says that they can take that change and monetize it into higher earnings. And it can be something like a brand or it could be something like intellectual property or a patent or something as simple as just their market positioning.
Pedro Marcal: So once we found the change and we've tested and confirmed that the model is sustainable for the company, we want to look to see that our views are different, that there's a differentiated view for us. And that's another way of saying that the stock price doesn't fully reflect these positives that we see. And we are looking to see that there's at least 20% upside before it can be included in the portfolio. And so, when you have these three components coming together, the positive change at the company level, the sustainability and strong business model, and this market mispricing then a company is a candidate for inclusion in the portfolio.
Pedro Marcal: Let me give you an example. So, we own a European semiconductor manufacturing company that is undergoing a new product cycle. So, what does the company do? So, the company manufacturers machines, which are used to print the circuit on a computer chip, and every layer of every computer chip requires this process. So, in their last generation of machines, they had 70 to 80% market share. In their new generation of machines, they have 100% market share. So, there's a new product cycle. So, the company has a lot of intellectual property and patents and has an incredible brand, which makes a huge moat for them to be able to monetize this change of this new product cycle. And we calculate that the earnings and cash flow that the company will be making from this new product cycle will cause the stock price to go up greater than 20%, so it meets our 20% threshold. So therefore, the company is able to be included in the portfolio. And in fact, we own this company, and it's performed well.
Remy Blaire: Pedro, let's move on to emerging markets. Could you tell me about the long-term growth opportunities that you see?
Pedro Marcal: First of all, emerging markets are cheap. But more importantly, in emerging markets there's a lot of change. And where we see change, we know investment opportunities are usually not too far behind.
Pedro Marcal: But you can't talk about emerging markets without really discussing the rise of China. Right? And China has had this phenomenal rise. GDP, in the last decade, has gone from $4.5 trillion to $14 trillion today. Incomes have risen by more than 30% over that time period, and you've had this rise of a consumer and a middle-class in China. And if you look at car sales, they've gone from 7 million cars a year 10 years ago, to last year, about 27 million cars, which is a phenomenal growth in demand for products. And more recently, that being said, China has run into some slower growth, and it's really a result of, in 2017, the Chinese government kind of starting to tighten policy, and then they were hit in 2018 with the trade wars that began with the United States.
Pedro Marcal: And so for us in China, where we're investing now, we're focusing on very stock-specific drivers, and we're being very selective about companies. We aren't in the sort of export manufacturing sector, as we once used to be, in terms of our investments. And we're investing in companies such as, we have a company that basically sells milk products and ice cream in China, throughout China, to this larger group of consumers and also a domestic sportswear and athletic shoe manufacturer that also sells predominantly in China.
Pedro Marcal: But China gets sort of the headlines but there are a lot of other great emerging markets you can invest in, and we're finding opportunities in India, in the rest of Southeast Asia, such as Indonesia, the Philippines, and in Thailand. And surprisingly, many of the companies in those areas are actually, to some degree, beneficiaries of the problems that the Chinese and the US are having with trade. If you look at Mexico and Thailand and Vietnam, they are beginning to get some of the manufacturing that is not going into China, is going into those areas as people try to diversify their manufacturing base. We own a company in Thailand essentially that sells 90% of its beverages in Thailand and Vietnam, and it's actually benefiting from this change of the trade issue.
Remy Blaire: And I'm glad you highlighted the second largest economy in the world, but also the implications of the US-China trade war and how these surrounding nations are benefiting. Now that you've covered that part of the interview, I do want to get your take on investment implications of the geopolitical issues that we face today. Could you give us some insight?
Pedro Marcal: Sure. Typically, geopolitical issues have investment implications. And you can look at the trade issue between China and the United States, the United States and Europe, and the European Union and the United Kingdom. No one knows how these are going to resolve themselves. But one thing I think is very clear is that whatever the resolution is going to be, it's going to be different from what the status quo was and what recent history was.
Pedro Marcal: So for us, we really, when we look at investing in Asia and in Europe, we're really trying not to be linked to the economic cycle. We're looking for companies that are benefiting from change but are much more company specific. So, in Poland, we own a gaming software company that's rolling out a new game. That's very product specific. And we own a British company that finances litigation, which really has nothing to do with the economic cycle. And I think that's important because sort of no matter what's happening in the world and what the geopolitical implications, if you're focused on change, and you're focused on investing in companies that are benefiting from whatever the change is, there may be investment opportunities.
Remy Blaire: Last, but not least. Pedro, let's take a look ahead. So, can you share your global outlook moving forward?
Pedro Marcal: I'm optimistic. Longer term, the developed markets in the US economy are in a really good place, despite some of the issues regarding trade that we've discussed. Structurally, the US has cut taxes. Our corporate tax rate went from 35% to 20% two years ago. We implemented broad reforms on deregulation, and interest rates are low. The Federal Reserve seems to be more of an easing policy stance right now, and we're at full employment, and the consumer looks healthy. So that's an incredibly strong backdrop for corporations, and it also sets a great foundation for future growth in the United States.
Pedro Marcal: Internationally, I think it's a little bit more of a mixed bag, but valuations, as we've talked about earlier, are very cheap, and when it becomes clear the US is not going to be going into a recession, I think that these markets are going to do very well.
Remy Blaire: Well, Pedro, thank you so much for joining me today, and thank you so much for sharing all of your insights.
Pedro Marcal: Thank you.
Remy Blaire: And thank you for watching. I was joined by Pedro Marcal, director of international equities at Foresters Financial. From our studio in New York City, I'm Remy Blaire for Asset TV.