Jonathan Forsgren:

Hello and welcome to this asset TV International Investing Masterclass. Our panel of experts will discuss where they're seeing risk and opportunity in markets around the world. Joining us today are Danton Goei, portfolio manager for Davis Global and International Strategies Group at Davis Advisors. Jason Chen, senior research analyst for the DWS Research Institute, and Rand Wrighton, senior managing director and portfolio manager Analyst at Barrow Hanley.

So Rand, we're going to start with you. Political tensions between the US and China have been on the rise over the last few years. Issues ranging from intellectual property rights, TikTok user data, human rights issues, the disappearance of high profile figures, you name it. So all this has asset managers and investors wondering, is China investible and is it worth the risk, if so?

Rand Wrighton:

Sure. Well yeah, thank you, Jonathan. It's great to be with you and it's certainly interesting times when it comes to China and it's certainly been a bit of a whirlwind. If you think back a few years ago where a lot of managers had large exposures to China and then you've had these events unfold and you've had the dialogue shift now to can we even invest there? Our view is absolutely, China is still very much investible. In fact, it's a very large deep liquid market with still a lot of opportunity to come over the next five, 10 years plus. But clearly there's some more hair that exists when you're analyzing the opportunity set, thinking about the backdrop to the market and other aspects that need to be considered before you invest client capital into the Chinese market. I'd say a couple of the bigger issues that have been topical, Taiwan, this has obviously received a lot of press.

There are a lot of folks worried about potential hot engagement. They're worried about the pressuring, the diplomatic back and forth, and can that have an impact? We don't think that's really going to materialize. We think it's a bit of a red herring when you think about what it would take to turn that into a military intervention with China going after Taiwan. We think that's not even on the table for the foreseeable future, both from a logistics capability standpoint, but more importantly from a goal standpoint of what China wants out of Taiwan. Ultimately, we think it's going to go more of the route that they went with Hong Kong in terms of lobbying, getting the elites on board a along but steady campaign to increase the integration and the cooperation with Taiwan. But what we'll have to see is that that plays out, but we don't think that should really factor in to people's calculus when it comes to investing in China.

I think that the growing tension with the US is perhaps a different matter that's going to have, we think some real intangible consequences when it comes to the different industries, but they don't have to necessarily be negative for the Chinese markets. Clearly you've seen a bit of a rift develop between the business and political classes and in both countries, frankly, when it comes to China, that's in part due to the fact that China is at a point where the population demographics are rolling over. Driving high single digit economic growth is not as important as it once was. Other political priorities have come onto the table, and so you're seeing a bit of a shift to the more political geopolitical angles taking priority in terms of Chinese domestic politics. At the same time in the US you're seeing a similar rift where a lot of US companies have invested what they're going to invest in China.

They're now looking at other markets. They're really just looking at supplying the Chinese market with their footprint in those areas. And so it is less important. They're also increasingly concerned about intellectual property theft, and so they're not as big of advocates for the Chinese point of view as they once were. At the same time, the political class in the US has moved a little bit more towards thinking about the strategic prerogatives. So I think that's going to create on both sides some increasing tension. And I think from China's perspective, they're going to want to increase their sphere of influence, the supply chain that's tied to Chinese and dedicated suppliers, particularly around technology. And so that'll create some redundancy. In the same way though that protectionism tends to also create some stimulus, some opportunities we think for domestic oriented companies that could represent opportunity. I think investors always need to be mindful and careful though that China is an emerging markets country and the politicians and the government have an enormous say in what is allowed to happen, what is not allowed to happen.

They have a hand in picking industrial and economic champions. We saw that on display as they humbled Alibaba. They've enforced certain breakups and management changes. That's always been par for the course in emerging market countries. I think some investors forgot about that given the spectacular run that some of those industries and stocks had, if you think about the tech champion champions in China. But that was always part of the equation and I think investors need to have a discerning view when it comes to those risks and value the assets appropriate. So we actually have a significant overweight to China. We think there's a lot of opportunity. We think the valuations currently reflect extremely negative scenarios that we don't think are realistic and there's a lot of great asset value. So that's how we're thinking about it right now.

Jonathan Forsgren:

And Danton, you have a handful of select in investments in China, despite the headwinds that we've just touched on. What do you say to investors that ask you why bother in China with all the headwinds that you're faced and how are you separating the opportunities from the risk?

Danton Goei:

Yeah, we get that question a lot. Why bother? And I think certainly after the past couple of years of performance, people have thrown up their hands and some people have just given up and walked away. And to start off, there are certainly risks and I think we address some of the major geopolitical risks and there's our top of mind and you have to think about them. But if you think about a few long-term and a few more near term opportunities, when you think long term, why China? Of course the size and the growth rate, the second-largest economy, second-largest stock market and the economy growing at a higher rate than average, certainly higher than other developed countries, than developed countries out there, then that's an opportunity. But then also I think people forget about the long term record of wealth creation there. Certainly the last five years, if you look at the MSCI China versus the SNP, there's been a big gap.

The China index is underperformed by quite a bit there. But if you look over a 20-year period, even including the last five years of underperformance, the MSCI China Index is right on top of the SNP 500 performance within 20 basis points or so. So really good long-term performance even despite the recent negative performance over there. And if you think about the quality of the businesses over there, big picture, the qualities have been increasingly better and better over time. Highly innovative entrepreneurial companies over there. If you think about companies like a Tencent or a Meituan over there, and also you think about increasingly you hear companies saying that we have to be there even though it's a difficult market because the competition's going to make us better. So a recent quote from the former president of the Euro Chamber of Commerce over there in China talking about the car manufacturers, how they have to be there, it's the biggest car market in the world.

It's actually become now the largest car exporter in the world in the beginning of this year. And he's saying how being there makes their companies, the German manufacturers more fit. And so the competitive level over there is often at a higher level and it makes for better companies and products. So those kinds of big picture and then nearer term we're expecting, and a lot of people are expecting government support for the economy. They're in a position to do so because they haven't had the zero interest rate policy that a lot of countries have performed out there. So they have room to move down in terms of interest rates and support the economy. They've been already reducing the lending requirements, reserve requirements for the banks. So that allows them to lend more. And they're also supporting increasing the property sector, which we know is a very important part of the economy over there by making banks easier for them to lend to the property developers.

And also expectations are for maybe reduction in the down payment requirements for residential. So that support there I think is very beneficial. And then we also know that during COVID, there's been a huge amount of dry powder built on the consumer side. Urban savings rates went into COVID at a very high 34% rate, which is already an incredible rate and has jumped up to 38% during COVID. As a result, bank balances relative to before COVID are up 59%. These are household bank balances. And then the resulting excess savings now is about 118% of an annual pre-COVID retail sales. So over a one whole year of retail sales has been saved.

Now it hasn't been put to use immediately in the post-COVID period in the weeks and in a couple of months afterwards, but that's sitting on the sidelines as well. So that's really attractive. And then finally, I would say just the valuation, right? The valuation now. If you look at the MSCI China index training about 10 and a half times, SNP at 19.6 times, that's a big 46% discount, nearly half the PE multiple as a starting point. So those are some good attractive near term for what we think is long term still an interesting and very meaningful part of the world economy that you as a global investor have to be interested.

Jonathan Forsgren:

And Jason, as a result of the tensions that we've talked about, we've seen the CHIPS Act and other efforts to nationalize crucial technologies or critical technologies. How has this impacted, one, companies who do business in or with China. And two, investing in China's equity markets directly?

Jason Chen:

Yeah, I would echo what Rand and Danton said, which is a lot of this negative sentiment is reflected in investor positioning and the valuations across those markets. You still have quite strong domestic growth. You have the dry powder that Danton mentioned. Obviously the regulatory specifically the nationalization of supply chain across various industries that's going to, I think naturally have to be reconciled over time. It's going to require factory builds and things along those lines. But in general, the strategic outlook for the Chinese equity market is still quite strong. I think to some degree you have in a lot of emerging markets, sentiment is such a big driver of those valuations and you just have such a depressed sentiment at the moment. We actually think that if anything, the regulatory environment has a chance to loosen a little bit, we wouldn't say dramatically, but China has a lot to navigate socially and politically at the moment.

And so it's probably in their most strategic interest and they're very strategic thinkers, to be a bit more accommodative to, let's say, the best companies, the tech companies, and even the property and banking sectors that are just integral to the function of the economy. So I think in general, the valuations are quite compelling. A lot of those risks of regulation are more than priced in as both of these guys said already. And yeah, it's a very strong strategic market. And like Danton said, you cannot really ignore it when you look at the composition of the world. And over time, that's going to shift towards one of greater representation from China as well.

One specific point I think on local Chinese equities that I think people often forget is obviously, as I said, they're very sentiment driven. They can be volatile. But they're actually a much better diversifier against other regional equity markets than basically anywhere else in the world. So if you look at a 12-month correlation, for instance, of the Asia market versus the SNP, it's about 0.3 to 0.4. If you're looking across developed market regions or even emerging markets more broadly, you're looking at 0.7 to 0.9. So from a portfolio construction standpoint, I think also it is quite compelling in that you don't really take the volatility or risk at face value. You have to really think about how it provides, let's say, somewhat differentiated return streams versus the rest of the world.

Jonathan Forsgren:

Danton, continue on this, the impact of CHIPS. Samsung is one of your top holdings, and while it's a Korean company, it is impacted by the CHIPS Act. So what is your investment thesis for the company?

Danton Goei:

Yeah, thanks. You're right. I mean it is impacted to a certain extent, but only peripherally. They'll benefit potentially from some of the benefits of the CHIPS act, but on the other end, they might be restricted in terms of their growth in China. Now, we've heard news recently that those extensions and their ability to invest and grow, that their Chinese business have been extended by the US government. So that's favorable actually for Samsung and their other Korean competitors that are on the Chinese market. And then just generally we think Samsung is a terrific company. It's the largest and probably the most important company in Korea. They're leaders in three terrific business. So first the handset. They're actually the world's largest handset manufacturer out there with a number one market share, 23% global share of all handsets.

And interestingly, them and Apple are really the only two profitable handset manufacturers out there. Samsung has the high-end androids, and then of course we know Apple has been very successful as well. Together they're over a hundred percent of smartphone profits. So very profitable business there and growing, they had over about 260 million units shipped last year. So that's a very profitable business for them. And actually they have a big margin opportunity there as well. So big. And then opportunity to improve the profitability there because during COVID, the supply chain issues caught up with them. And then their other second business, and that's really the gem of the business, gem of the overall company is the memory business, the semiconductor memory business. So they are the leader in both NAND and DRAM business. So in DRAM, they have over 40% share. And DRAM is the memory that's very fast, that's used for basically compute making calculations.

So it's volatile, meaning that if you turn it off, the computer goes away. But for computing, it's very, very essential. And so when you think about all the instances of computing, those are obviously growing very rapidly. So you think about Cloud computing, computer virtualization, data analytics, and of course AI. Those are all big drivers of DRAM demand. So they're the number one by far with over 40%. And then in NAND, which is solid state drive, it's the more persistent memory, that part, it's also growing very, very rapidly. It's replacing the solid state drive that we all grew up with. And then just basically if you think about all the mobile devices out there, smartphones obviously, but other ones, they all require the NAND memory. And then even automobiles, which increasingly people talk about as computers on wheels, those also require NAND storage memory.

So the instances and the demand for memory, both DRAM and NAND are growing very, very rapidly. And then finally the third business is the foundry business. So them and TSMC are really the two only foundries out there that have leading edge technology and they make the CHIPS for all of these fab, very successful semiconductor companies out there. So Nvidia, Qualcomm, and then the Cloud computers like providers like Amazon or Google or Microsoft, none of those make their own CHIPS. They design them and then they have Samsung and TSMC make them. Most of them have a second source.

So if you're going to go first with TSMC, then have Samsung or vice versa. So they're both very successful and that's also a very fast-growing business. So all three handsets, the memory and the founder business are very good businesses and profitable. And then finally, the valuation is really attractive. Right now, the memory business is in a down cycle. But if you look at next year, they're trading at about nine times earnings. You look at a few more years, it's even lower than that. So that's obviously a great starting point. You think about sub 10 times earnings for a company of this caliber with a fortress balance sheet, over 20% of their mark cap is in cash, so no debt. And then the growth business they have and that type of starting multiple, we think that Samsung Samsung's really attractive

Jonathan Forsgren:

Rand, China's May exports, were down 7.5% year over year. And as we've touched on the post COVID growth story that everyone expected from China hasn't really played out as Danton has said. It sounds like it's sitting on the sideline, but it hasn't really entered the market. Is this a bump in the road and what are you seeing as some of the largest potential threats to China's economy?

Rand Wrighton:

Sure. No, that's a great question. And look, I think markets tend to be a little impatient. I would argue that the Chinese market equity market got a little ahead of itself. I think people have to remember just how long and how hard the country was locked down. And you really only exited that zero COVID lockdown in early December. And I think that was met with a heightening of the geopolitical tensions, which I think has served to worry people in China. And I think Danton properly referenced the high savings rate and that's gotten even higher. But I think in terms of it, that savings actually getting out into the market and typically you're going to see it go one of three places, property, consumption or the stock market itself. But I think people need to get confident that life is truly normalizing and that there's not another huge overhang there.

And things like youth employment, unemployment, are a concern. But I think broadly speaking, I think what's really all that's required is a little bit more time passing some stabilization. We're looking for a very strong back half of the year in terms of the acceleration in normalization in China, things like travel. You're already starting to see travel and leisure start to normalize, and we think there'll be more of that. And I think some of it is just a matter of getting a little more time past the removal of the lockdowns and tamping down some of the geopolitical tensions, which we think will happen. And I think you'll start to see that the savings deployed and acceleration in economic activity. So we think that the biggest risk would be a re-acceleration in accident in geopolitical realm, if you will. That's not our base case. We also think that the market tends to assume that the policymakers will be static.

We don't think that's the case either. So if growth is underwhelming, I think policy measures will be targeted, but I think they will change and they will increase. And so I think the government and China has signaled very clearly that they want to see economic activity pick up. They're not going to go all in, but I think you could expect them to change accordingly if they're not achieving that. So on balance, when you put that outlook next to the cheap valuations that we've already talked about, as well as I would argue the press levels of profitability in a lot of the industries, we think that sets up for a very nice earnings acceleration, cashflow acceleration, and we think that the equity market will follow with a little bit of time.

Jonathan Forsgren:

I'm going to ask one more question here. So do you see China's political parties hold on the government and Xi Jinping's third term as a potential boon? Or could it be a threat in that it might stifle innovation?

Rand Wrighton:

Boy, that's a loaded question, that's a hard one to answer. Right? I think, look, trying to look past two or three years in China is an awfully difficult thing to do. I think for now that the next, call it three to five years, I think we have what we have there in terms of if President Xi having really consolidated power, I think he made it very clear that he's running the show. And I think longer term outcomes with China are going to depend on a lot of different scenarios with regard to policy succession, et cetera. But look, I think that we are at an interesting point where for a long time China really benefited from free technology transfer. A lot of your big Western US, European companies, they wanted to play in the Chinese market and they readily transferred low and in some cases middle-land technology, they also transferred business knowhow and business recipes.

And that was a huge accelerant for the development of Chinese industry. But you're at a point there where there's not going to be any more of that going forward, and the Chinese companies have to tick up the ball and prove they can drive it further from here. One of the things that we look to see any tangible progress there is how do the large Chinese corporates that are able to export, how do they do in terms of market share gains and other primarily frontier markets? Are they going to be able to compete internationally with the Western companies? They haven't really proven that they can. They're obviously a lot of innovative folks in those companies have done a very good job. Many of Chinese companies are growing and innovating for that market, but I think the jury's still out, and I think the next 10 years obviously will be a lot more difficult on that front than the last 10 were for that reason. But we'll have to see.

But in terms of the policy, look, I think the legitimacy of the communist party in China still resonates with their ability to deliver for the people, both in terms of economic opportunity, jobs, and obviously prestige and security as well. So those are all intermingled and I think you'd be hard-pressed to make a case that you're going to see a slowdown in efforts on those fronts anytime soon.

Jonathan Forsgren:

And sorry to throw the tough one at you there. So we're going to go across the water here. Jason, Japan's Nikkei is up 14% this quarter and it's closed at the highest level it's closed at in 33 years last week. Why is Japan seeing this growth and what does this mean for international investors?

Jason Chen:

Yeah. So I think the run-up means that perhaps, so foreign investors in general have always played a large role in the fluctuations in the Japanese market. And this is certainly a time that reflects that. To some degree, I think it's gone a little bit too far in the short term, but we think there's a lot of really strong reasons why Japan has some really structural, or let's say, medium to long term tailwinds. So we think Japan is an alternative way to play the Chinese reopening. The valuations in spite of the returns recently are still not overly demanding. If you look at a macroeconomic level, you have, let's call it low, but still steady growth outlook. You have until proven otherwise still an accommodative central bank. And you see some of these longer time dynamics as well. If you look at labor costs, for instance, basically Japan was not competitive on a labor basis for 20 years. And now after resetting that level, they are more in line with, let's call it the rest of the developed international world. And so I think that bodes very well for the competitiveness of those companies.

Jonathan Forsgren:

Sorry, I'm going to stop, just out of curiosity. So is it that the labor cost in other areas of the developed world have risen or Japan came down?

Jason Chen:

Japan came down.

Jonathan Forsgren:

Okay. Yeah.

Jason Chen:

Yeah. Yeah. And then I think in addition to that, and this is one, I think it's hard to get too excited about this because the story seems to come up every seven to 10 years, but you are seeing a slow and gradual change in governance. So you do see corporate governance for companies lean a little bit more favorably towards investment, and that is something that takes a long time to play out. But when you have depressed valuations in general, I think perhaps it's not a difficult thing to step into a cheap equity market and play for that potential long term reform.

Jonathan Forsgren:

Rand, I know that you've had some interest in Japan. What are your thoughts on the Japanese equity market and this growth spurt we've seen recently?

Rand Wrighton:

Sure, yeah. Listen, we think Japan is really interesting right now. Earlier in life I had the opportunity to live in Japan for a while. I have to tell you, I think it's a remarkable country. What they've done with building businesses and their economy post World War II is astonishing. And I think they really obviously went into a huge malaise over many decades. We do think that they've come out of that. I think what we've seen recently is an acceleration of what began about 10 years ago under Abenomics, where you started to have a bigger emphasis on the corporates actually delivering value and restructuring, returning more capital, divesting non-core businesses, paying dividends. Like most things in Japan, it began very slow and gradual. It was reinforced over time with some policies that came out with the stock exchange. And obviously it's still an emphasis from regulators where they're looking for more efficiency.

When you step back and think about what Japan has in terms of opportunity, you have a lot of globally strong brands, businesses, products, particularly in industrials and technology, but in other areas as well. When you look at the Nikkei, about almost half of the stocks that trade have near net cash balance sheets where there's a very significant runway to improve capital return to investors to come closer to a more optimized capital structure. And frankly, we think that you're also seeing very nice trends in terms of CapEx and global mega trends like automation moving in Japan's direction. And so if you look at more recently, the economic data has come through a little better than expected, but you've also seen a run of Japanese corporates announcing very shareholder friendly policies in terms of announcing big buybacks. Just in the last few weeks, we've had a number of our portfolio companies come out and announce three to 5% of market cap outstanding buybacks alongside increasing dividends commitments to focus on things like return on equity, which has not always been the case.

So I think when you bring all of those things together, it makes for a fairly strong case for Japan. That being said, we've obviously had a bit of a run. We're seeing a bit of a run in the last few months, so perhaps the market needs to cool off for a little bit, but very constructive in terms of the trends there. And we think the opportunities and longer term, I think we should always remember that there's a significant opportunity if the local Japanese investors in turn a little bit away from having so much fixed income into actually the equity markets, that could be an additional and material tailwind over time.

Jonathan Forsgren:

Danton, I'm going to give you the opportunity. If you have any thoughts on Japan, please feel free to share. Otherwise, you're going to get the first question on Europe.

Danton Goei:

Okay, that's fine. That's good.

Jonathan Forsgren:

Up to you,

Danton Goei:

We can move to Europe. It's fine. Yeah.

Jonathan Forsgren:

Okay. So Danton, revised numbers show that the Eurozone has fallen into recession in the last two quarters, mild recession, but indeed by the most basic term or definition of the term. So as a value investor, do these types of headlines typically mean there's a value play out there for you?

Danton Goei:

Yeah, Europe has been obviously an interesting place over the last year, year and a half. We think of us and Asia, lots of things happening, but obviously with the February invasion last year of Ukraine, that was a big shock to the whole Eurozone, big increase in energy costs. And so the stock market reacted there as well. But since then there's been an improvement in sentiment. And then also energy costs have come down quite a bit since then. And so the stock market actually since fall of last year is up about 30, over 30%. So it's been slowly recovering from the Ukraine shock. And then the economic news, although it's shown weakness, is maybe actually maybe slightly better than people had feared, people really worried about worse than a mild recession. And so the stock market has reacted. But the stock market is still relatively attractive.

The multiple there in general, if you look at the Euro stocks 50, it's about 12 and a half times earnings. So that's a big discount to the SNP in an absolute basis, attractive starting point. But if you look under the hood there, it's a really bifurcated market. If you think about, there's a lot of old industrial companies in there that make up the index. So you're thinking about the old Fiat Stellantis, the German auto manufacturers, BMW, Mercedes, they're all trading between three and six times earnings. So very, very, very low. And then you also have old mega bank corporations over there. So I'm thinking of a BNP Paraiba or a Santander or ING over there, and those are trading between five and seven times earnings. So if you take all those old older economy companies, you're talking right about five, six times earnings there for a big, big block of the index.

But we would say, you might want to be careful about investing in those type of companies just because they have a low multiple. Of course, they have balance sheet issues and their outlook for future growth might not be that great. And then you have the companies that you might be really attracted to, those that are considered consumer goods companies with brand names that are often over a century old. And I'm thinking there of companies like in Hermes or L'Oreal, but those companies, L'Oreal's over 30 times, Hermes is over 40 times. So those are big multiples for definitely attractive companies. But you can see it's a barbell type of index.

Jonathan Forsgren:

How do you reconcile that difference?

Danton Goei:

Right. So I think you know, want to look for not necessarily the companies there at either end, but we have some attractive industrials that are trading at lower multiples that are multinational. So when we are looking at Europe, we're often looking at multinational companies that can take advantage of growth here in the US but also in emerging markets across the globe, not just reliant on say German or Italian or Spanish demand, which is been relatively weak.

And so there we have an investment called Schneider Electric. It's a French company, but it's really a global electric company that can take benefit of electrification globally, including say in India as urbanization grows there. And then also we own a number of select financials in Europe, but not the large mega banks, but really the leaders in each of these smaller economies that are well run such as the Scandinavian countries or such as Switzerland, and there the multiples are also very attractive. So I think active investing can have a big advantage there and such a barbell driven market and finding select opportunities where either end might not be that attractive, either sacrificing quality or in fact sacrificing valuation, try to look for ones that are more in the middle, that maybe you get both of those things valuation and quality on your side.

Jonathan Forsgren:

I'm going to ask you this because you mentioned financials and we saw in the US the collapse of a few handful and Credit wasn't a collapse, but it was an assumption of the bank. So in the banking sector in Europe, are they seeing similar stress and could we see other banks go?

Danton Goei:

Yeah, that's a great question. And so we definitely saw that here with the US regional banks, a lot of stress bank runs the Fed having to intervene. And in Europe we haven't seen a similar dynamic. Now the dynamics are very different there. You don't have different classes of banks like here with the large and the smaller banks with different regulations. There, they don't have as big of a differential over there. And also if you look at a country, say Denmark, and you invest in a bank like Danska bank, it's the leading bank there by far. And if there's going to be some worries, they're not going to be leaving a Danska bank to go elsewhere, they're going to be the one that's going to be getting all the assets if there was an issue. But there hasn't been any the same concerns over there.

So when we're looking at the European financials, we're looking for the leading bank in some really well run economies, so Denmark or like in Norway with DNB also similarly, market leading position, supported by the government. And these banks are trading at very attractive valuations, about seven, eight times earnings with dividend yields from six to 7% a year. So really, because if you have a 13% earnings yield, you can afford to give out half of that in dividends and you've got a 7% dividend yield. And so those are really attractive, starting point in terms of the multiple starting point in terms of obviously the dividend yield and then also just the safety that you have in these banks. Or a bank like Julius Baer that's slightly different. It's a private wealth manager, but it's one of the premier private wealth managers out there.

And you're talking about the assumption of Credit Suisse by UBS that actually over time should benefit Julius Baer. It's just less competition in the private banking both in Switzerland and then globally as well. And so they've actually been growing the number of relationship managers and being able to choose some of the best relation managers out there now that they're available and grow their business that way. And that can have a lag, a one or two year lag before that really grows their book. But over time, those experience relationship managers are able to attract business to the bank. So I think a company like Julius Baer is also really attractive. They're trading about a 10 times multiples, also attractive starting multiple for what should be a decent growth business over time, which is basically global wealth management over time. So I think if you're very selective in some of the financials in Europe, you can find some real gems.

Jonathan Forsgren:

And Jason, what is your take on European equities and Europe as a market as a whole?

Jason Chen:

Yeah, so I would say that we're somewhat constructive on the region. On the one hand, I think to Danton's point, you do have a lot of cyclicality in some of these companies. Naturally the beta of let's say the European equity market, particularly when you account for the Euro exposure as well, it tends to be a bit higher than the US for instance. So it's hard to get very bullish when the economies are slowing. But if you look at the macro picture, Europe is still relatively stable from a growth standpoint. And the point of valuations too, I think as Dan mentioned, both on a relative to its own history, but I think particularly relative to the US, it's cheap.

I do think there are some interesting ways of playing it as well. So I think high dividend type strategies lend themselves to not only just income, but also that persistent earnings yield generation that was just mentioned, finding stable companies that are not expensive that can generate that free cash flow and service those dividends, I think is actually a really compelling way to play a market that's balanced in terms of the risks and the potential positives.

Jonathan Forsgren:

And you can also chime in here, do you think these companies that have healthy dividend payouts over the last few years will be able to sustain though that pattern in a slowing economy?

Danton Goei:

Yeah, I think that some of these banks, for example, they don't require a lot of growth to do well. They're already starting at very low multiples, seven times earnings, less trading, [inaudible] been trading at less than book value now they haven't started paying out their dividend yet. That'll start likely next year. So you have to be a little bit patient before you see that big payout, but they're amassing capital right now. So those type of businesses don't need a lot of growth when you're starting at low multiple, have very high dividend yields. Those probably do great despite slower growth.

Jonathan Forsgren:

And Rand, you have significant exposure to Europe. Where are you seeing the opportunities right now in the region?

Rand Wrighton:

Sure. Yeah, listen, we do think Europe is interesting right now. And I would echo that the sentiment around dividends, most people forget that more than 40% of your long-term total shareholder return in international markets comes from the compounding of cash dividends. I think on the other side, people have to realize that the European market really doesn't have those tech champions. That's one of the real differences if you think about the US and also Asia, where you have some really strong technology companies that have really benefited over the last 10 years and frankly are still probably very good long-term bets, but I think we're at a point where they've really cooled off. You pulled forward a lot of demand post COVID. And so when you look at the European market over the last 10 years, it's really, really underperformed the US market. And you've had clearly the geopolitical issue with Russia, Ukraine. You had a huge squeeze in terms of input costs going up at the same time that you've had a lot of economic stress with places like Germany and recession.

And so we look at it a little bit more in terms of the cyclical opportunities in Europe, but we also have a bit of a barbell exposure in terms of the asset classes or industries. And we think that both consumer staples in Europe and also materials in Europe are very interesting. They both had similar dynamics where in terms of consumer staples, you've seen a number of really high quality companies that get pressured in terms of the inflation, the squeeze on their gross margin at the same time you had softening in their end markets. And so the businesses were squeezed. We think that over a longer period of time though it's a very high percentage bet, they'll be able to pass along the cost increases. You'll also see some relief on the input costs and you'll see margins re-expand, valuations improving, and you're clipping nice call it three and a half percent dividend. On the other side, on materials which tend to be more cyclical and more volatile.

We think the entry points right now presented due to that sharp rise in feed stock costs that the surge you saw in natural gas in Europe and inputs at the same time you saw this overhang of recession and people obviously panic in these kinds of stocks given the cyclicality, the huge operating leverage. But again, there's some really good assets here that have strong balance sheets that pay high dividend yields. There's some opportunities where we think you get mid-single digit dividend yield, no real risk from the balance sheet, very strong long-term business case, good management teams. And frankly right now where the stocks are, they've sold awful lot. We think they're at good entry points. So those are some of the areas that we think are really interesting about Europe.

Jonathan Forsgren:

We've talked a lot about Europe and China when we talk about the global global economy and global investing, and surprisingly India doesn't get that much attention considering its size and the most populous country in the world. And Danton, you recently returned from India. Are you seeing opportunities in the region? Is it going to be a more prominent area for investors to consider?

Danton Goei:

Yeah, India is a country that, like I said, maybe sometimes doesn't shine the limelight, but certainly for a lot of emerging market investors has been a star. The last few years has been very strong growth both on the equity side but also just overall economy. It's amazing to think that in 2014 they were the 10th largest and now they're the fifth-largest economy less than a decade later in such a short period of time. So they have been experiencing a strong growth. And then when I went there recently, it was amazing to see just a hundred percent out of the 25 companies I saw and all the individuals saw, a hundred percent people were optimistic about the future, which is very rare. Obviously if you came here in the United States, you would not get that, you went to China, you wouldn't get that.

I can't think of many other places you would get a hundred percent optimism. And there's some good lot of good reasons, the recent growth, but also they've made some structural changes over there that have been very important. President [inaudible] pushed through. The good and services tax, that was a big deal. The bankruptcy code reform, that was also a really a big deal. And then corporate tax rationalization.

So those have all been really important in the structure and the pillar that underpins all the optimism and growth that's been going on now. But as a result of that, the market multiple there is about 20 times earnings. And so that's a high starting multiple for the overall one and a half percent dividend yield, relatively low. So that's a high starting point. And then if you peek under the hood there and think about, okay, what are the companies that I'm really interested there, a lot of the consumer brand companies, like a top food company like a Dabo there is trading about 45 times earnings.

So more than double the market multiple. Even industrials like an Asian Paints is trading at over 50 times. Some of the breweries over there are trading at 50 times earnings. So those are all really high starting multiples. So I think India's a really interesting long term. There's a lot of positive trends there that structural changes we talked about. Demographics are very much as in their favor, and now you hear more and more about moving supply chains towards India and the government pushing policies to support that and attract global manufacturers to India.

So those are all positives. A lot of it built obviously into the valuations and multiples. So I think as value investors, we want to follow there, we want to keep on visiting them, we want to have a shopping list, have an idea of the companies that we find really, really attractive, but probably be patient on the valuation side. We know that unfortunately things always happen, whether it's geopolitical or economic or otherwise. And so we're in the wait and see patient mode, but it is long term, I think, a very attractive market.

Jonathan Forsgren:

And you touched on French [inaudible], how much do you think it'll benefit from French [inaudible]?

Danton Goei:

Yeah, I think it'll take some time, over time. These ecosystems cannot be built overnight. You need all the suppliers and all the small little pieces that are required for each of these products. And you see Apple moving there slowly, but really just some smaller products. And I think a lot of companies are going to be thinking of the same way. They're not going to put their main product there immediately, but think of trying to grow it over time. So it's going to be certainly a multi-year, maybe even a multi-decade type of thing.

Jonathan Forsgren:

Jason, internationally, where does DWS currently see the best opportunities and why? And then what are the risks to those views?

Jason Chen:

Yeah. So I think we walked through Japan and Europe, which I think there are real benefits to those markets as well. But as we mentioned Japan, perhaps the sentiment has gotten a little bit ahead of itself. In Europe, the cyclicality I think makes it hard to get very bullish. I think where we see more, let's say pros and cons is emerging markets Asia, and really it's a reflection of, you are getting exposure to this China reopening story at relatively cheap valuations. So that's really where I think from a symmetry standpoint, there is the most upside versus downside. The risk to that obviously is this region is also tends to be quite cyclical in its nature. And so I think any global slowdown, let's say, beyond what is the consensus at the moment would obviously have adverse effects on EM, but EM Asia as well.

Jonathan Forsgren:

And then are you telling your investors any particular way to gain exposure to emerging markets, Asia? Any ways that in particular that you'd favor?

Jason Chen:

Yeah. And this comment is not specific to EM Asia, but I think one of the things that we've been trying to get investors a little bit more conscious of is the assumption of currency risk when they're investing internationally. So I would contrast this strongly with anyone who has a global ag benchmark, it is always currency hedged. And the reason is that the volatility that the currencies contribute to the portfolio are too much to justify on a strategic basis. I think the same math and the same logic can be applied to equities as well. When you are investing internationally, owning the currency is in additional view to owning the equity. And so I think just being thoughtful about whether you want to assume that currency risk is really important. If you look at developed markets, the currency usually adds about two to two and a half volatility points.

If you look at emerging markets, it's three to three and a half points of volatility, which is quite significant proportionate to the local equity volatility. And I think right now with the availability of currency hedged options under those markets, it makes it increasingly easy. In the past, I think some of the hesitation in taking on the currency risk or not being conscious of it was, how do I do this? Do I trade all the FX forwards? Now I think it's much easier to navigate that at the index level.

And one of the things also is the US still has much higher rates than most developed markets, and that materializes into a significant FX carry. So if you look at the yen, for instance, on MSCI Japan, a one-month forward pays an annualized yield of 6.2% if you're a long dollar yen. The Euro, even though European rates are moving higher, still pays you 2.3%. And I'm not saying that you should never take the currency risk on, it really just depends on your view. But absent that view, you are reducing the volatility of your portfolio by two and a half or three and half percent depending on developed or emerging. And in developed markets right now, you're generating significant carry if the currency is sideways.

Jonathan Forsgren:

Rand, I know that you do currency hedging in your portfolios. How are you doing that?

Rand Wrighton:

Yeah, no, actually we don't hedge the portfolio positions with explicit hedges, but we do account for currency in two really important ways. Most of our investors when they put money to work in an international value product or an EM value product are looking, if they're interested in hedging, they would do it on top of all of their exposures as opposed to pushing that down into the individual portfolios. But where we pay really close attention to currency exposure is in two areas. The first is where we see a cost revenue mismatch. So if a company generates all of their revenue and cashflow in local currency, but a lot of their cost, if you think about raw materials or inputs into there, if it's a manufacturer are priced to dollars, significant movements in the FX rate can have huge impacts on the gross profit margins, which will flow through and impact the earnings profile of the business.

And we're typically looking to avoid those kinds of bets in the portfolio or looking at bets where you've had an extreme move against the company where we think any a normalization would be a tailwind. The other aspect that we look at closely with currency, particularly in emerging markets is where a company has issued a lot of debt in say, US dollars, but a lot of their cashflow revenue is generated in local FX. And those instances when you see significant movements in FX, the leverage profile of the business can change quite significantly. And that's where you can get into real trouble in emerging markets. So we typically avoid those businesses that have real mismatches of those natures.

Jonathan Forsgren:

And I'm going to stay with you. I just asked Jason where DWS was seeing the best opportunities internationally. Where are you and Barrow Hanley seeing the most compelling international opportunities and how are you gaining exposure to those?

Rand Wrighton:

Sure. We've obviously touched on Japan and a few in Europe, but I'd say when you peel back the onion a little bit and look in some sub-sectors where we see some opportunities that we think are at interesting entry points, would look to a couple different sub industries in automation, particularly out of Japan, we've got a number of companies that have nice exposure to the global automation end market. We think there's a big CapEx cycle coming related to retooling factories, new factories.

In fact, global CapEx has been sustaining at a very healthy level and we think there's some catalyst coming down over the next couple of years. The Japanese have companies that have very strong competitive positions within automation. We also think within defense, particularly European defense is an area that has been underspent on for many decades.

Obviously the Russia, Ukraine invasion was a wake-up call and some of those equities have started to respond, but frankly, there's such a long runway for normalization just to get to the NATO treaty levels. Maybe the last area I would touch on would be automotive. This is an area where you have to really pick your shots over time. It's tough to have buy and hold DCs in the automotive value chain, but we think we're at a point right now where there's some really interesting assets both within OEMs, but also within the tires' industry and then also in other niche areas like lighting, is one of the stocks we own in Japan that has very nice exposure to LED lighting that that's on cars as well as Lidar technology.

So we think when you look at the last couple of years, you've obviously had a lot of demand pressures, you had component shortages, and we think this year is going to be a much better year than last year. And we think that there's a nice runway there for improved fundamentals that should come through in those equities.

Jonathan Forsgren:

Danton, after more than a decade of dominance by US stocks, international equities are outperforming the major global indices and have posted strong returns so far this year. What do you think the next decade holds for non-US equities and what do you tell investors that are skeptical about investing outside the US?

Danton Goei:

Yeah, it certainly can be a challenge to get US investors at least interested in international equities after the last 10 to 12 years of US dominance. But one thing I think it's worthwhile doing is taking a big step back and seeing that these outperformance, US versus international, they go through cycles. So certainly the last decade has been a pro-US cycle. But before that, in the period before, say the decade ending in 2007, that decade saw international equities outperformed by over 300 basis points a year for a decade.

And then the decade ending in December '87, there you saw a decade of outperformance by international equities by over 600 basis points a year for a decade. So you can't have these big swings. And so now after a really strong pro-US decade where US is outperformed by a lot, you have this big valuation difference where the US multiple is almost 20 times and the international index is trading about 13 and a half times.

So that big difference there, over 30% discount in valuation makes for a very compelling starting point and might make you think that the next decade might be different than the last decade when you're starting from such a huge difference in multiple starting points.

And then lastly, I would just say the quality of the international companies, there's a lot of really strong, and they keep on improving quality companies. In Europe, we spoke about a lot of them and these brand name multinational corporations out there that are really attractive. In Asia, you have companies like Samsung or in Japan, a Tokyo Electron that are also really global companies that are really strong. In China, of course you've got a number of internet and technology companies that are... So I think when you look at the quality companies out there, the fact that they're trading is such a big valuation relative to the US and the fact that they go through cycles and we're at maybe towards the end of one of these big cycles that ended up in US outperformance, it makes sense to have increasing exposure, I think, to international for the next decade.

Jonathan Forsgren:

And how much of that US dominance, because we just sat out on 0% interest rates for almost the decade, how much of that performance was due to that free money really?

Danton Goei:

Yeah. No, I think that has been a big driver obviously for valuations. When you do discounted cash flow, that helps a lot to have such a low discount rate. But also the type of companies that are here. We have a lot more growth companies, earlier stage companies, tech companies that require a lot of financing and don't have the profitability and free cash flow at the outset. And those companies really benefited from this free capital basically and abundant capital. So I think yes, the US stock market did benefit from that maybe on a relative basis more than the international equities. And so that makes you think that now that we're not in that environment anymore, the next decade might be different.

Jonathan Forsgren:

Mm-hmm. And Danton, what strategies does Davis offer that provide exposure to non-US equities and how are they differentiated?

Danton Goei:

Sure. So we have both a global and international strategy. So global is international plus US and international is just only international. And then we have them in both mutual fund form with the Davis Global and Davis International Fund. Then we also have it in ETF form, actively managed ETFs, and then also separately managed accounts. So we have, depending on what the client needs are. And now they're all fundamental bottoms, up driven, valuation sensitive, valuation aware strategies. And so they're built company by company rather than a big macro look.

And what I think is really interesting right now is that over the last five years, both of those portfolios in international and the global, the portfolio companies have on average grown faster than the index. So there are higher growth type of companies, yet their valuations are about 40 to 50% discount to the market. So again, that bodes well I think for the future, when you have above average growth companies trading at such a huge 40 to 50% discount on a multiple basis, that should lead to good long-term outcomes, we think. So we think that's why it's interesting time to locate international and global strategies.

Jonathan Forsgren:

Rand, so we've seen government involvement and regulation more and more, whether it's tied to geopolitical tension or in some cases a bank collapsing. We've seen governments get more and more involved with these types of things. So how much is government regulation impacting your international strategy? And then please, Jason and Danton, chime in as well.

Rand Wrighton:

Yeah, for sure. Well, listen, I think it's really important to consider when you look at the trend over the last 20, 30 years, I think it's fair to say that that regulation only gets larger and more intrusive each year as do the expenses, so when you're looking at public companies complying the world is more complex, more interrelated, and so there's also a lot of cross jurisdictional issues and obviously now geopolitical tensions that factor into regulatory actions that might not be solely based on the business dynamics of the industry. I think when it comes to the banking and financial sector, policymakers have made the pathway pretty clear and that they're not going to repeat a GFC type of situation. They're going to wait in an effectively bailout or force a bailout of any moderately important bank or financial institution. You saw that both in the US, you saw that in Europe, and I wouldn't expect that to change.

So I think that's there to stay, and frankly, I think the business model is going to have to pivot in banking to just have that baked in and investors should understand that. I think where it gets a little trickier is around technology. Obviously, you've seen this escalating technology war between China and the US and Europe caught in the middle. There are a lot of natural monopolies that occur in the technology industry, which is creating issues. There are also a lot of increasing censorship issues that vary by geography and governmental jurisdiction, which are hard to disentangle. And we'll see what happens with AI. Obviously that's already garnered, despite being in an industry that's still really early stages, it's clear that you're going to have a lot of government influence on those businesses. But typically we're looking to invest in businesses where we can understand the regulatory backdrop, where we feel like it's at least a neutral or preferably a modest tailwind.

If we can't get clarity on the regulatory risks that are faced a certain business, we're typically going to step back. I'd say when you look at emerging markets, that's increasingly important. People have really been burned in China. If you think about when the government has come out against certain industries or been critical, if you think about the educational industry in China where they single-handedly crushed it, they had given signals, they had foreshadowed that that was coming. They had made several comments and policy statements on the record about how they didn't like the direction it was going. They made similar comments around video gaming and things in technology.

So in emerging markets, you have to pay especially close attention to what the policymakers talk about in the past that they indicate they might be going down because there's not the same rule of law and options to companies that are affected that you have in places like Europe and the US. But increasingly, even in Europe and the US, you need to be confident that any business you're investing in has at least the benign policy environment because it's going to become more important. And the power of regulators has gotten more significant and the issues have become a lot more complex. So we look to manage it and to avoid the blowups as opposed to thinking of it as a catalyst. But it's something that's baked into every single stock analysis that we do now where relevant.

Danton Goei:

Yeah, think Rand makes a great point of that, that regulation globally, I think government regulation is increasing, whether obviously we've seen that in China, but in Europe as well. We're seeing it certainly with big tech, but other industries as well with financial services where it's increasingly a big part of the investment analysis that you have to do is, what is the regulatory risk? And even here in the US, we can see that growing and AI regulation is coming, for example. Europe is just in the latest stages of developing theirs. China is a little earlier. Here. We're still in the nascent stage, I would say. But eventually I think you're going to see AI policies develop globally.

And even here in the US, we saw recently, say, things like the insurance industry where companies weren't allowed to increase their insurance rates for home coverage in Florida. And so insurers are moving out of the state. We saw that happen in California. That's happening in California as well right now. And so insurance companies are having to think about regulation, think about climate change and any potential impact on that too. So it is a big factor, I would say, in an investment analysis. And you just want to invest in companies that can do well despite this increased level of government regulation.

Jonathan Forsgren:

Jason, from a standpoint of factors, what are some of the characteristics of developed or emerging international markets that are in interesting to you and differentiated from what we see in the US?

Jason Chen:

Yeah, I think we've spoken quite a bit about dividends and valuations. When you combine, I think lower but stable, say, economic growth rates across international develop markets, you have higher dividend yields and cheaper valuations, which implies higher earnings yields. It does lend itself to higher dividend investing. I think people who are looking for income generation, it would be prudent to also consider high dividends outside of the US. You're able to generate, again, higher dividend yields versus, let's say, US counterparts. You are able to buy these companies at a cheaper valuation. I think these underlying market dynamics really position these sorts of strategies to have more of a natural place in these markets even than where we think normally in the US dividend investing. So I think it's just a way to access whether you want to call it factors or income, but think about it at an international level, not just focus domestically.

Jonathan Forsgren:

So we just got the news from the Federal Reserve after 10 consecutive rate hikes, they've taken a pause. And so inflation and raising interest rates have been in the headlines and leading the headlines for the last year and a half, two years now. So with this in the backdrop, what are your expectations for global interest rates and inflation over the next 12 to 18 months?

Danton Goei:

You want me to start?

Jonathan Forsgren:

Yeah, please, Danton. Okay, let's go.

Danton Goei:

So you're keeping the easy question for last, huh?

Jonathan Forsgren:

Yeah.

Danton Goei:

I know, obviously that's very hard to know and in Juli Baer's words, forecasting is difficult, especially when made about the future. But what I would say is that we know that we're coming out of a period of massive distortion. So we know that the last decade has been a very abnormal period. Even looking at the long length of history, zero interest rates for that length of period is not something that we've seen before and it's created all kinds of distortions. And we're moved past that now. And so whatever the exact numbers are for the next 12 to 18 months, they're going to be in a band of much more normalized inflation and interest rates. We'll see about the inflation. It's been a little higher than next expectations, but we're seeing them tamp down and like you said, the Fed reacted to that by pausing.

I think our expectation is that it's going to be probably higher than say the target of 2% for quite a while. There's some stickiness in there, especially at the wage level out there in the US, but also just globally. But interest rates are now at a much higher level than they were 12 or 18 months ago. So that's having an impact on that.

So you want to have companies basically that can do well and adapt to this new different environment than has been the last decade. So what you want to avoid, I think are companies that require cheap financing, that require a lot of cheap available capital to grow. That's probably not avail as available anymore. So you want to have companies that are self-financing, generating free cash flow, strong balance sheets don't have a lot of debt. If you have a lot of debt that's going to roll over at these higher interest rates, that can have a big impact on the health of your business. So those type of businesses you want to avoid. And then you want to have the ones that are self-sustaining, real moats, highly competitive, and with strong balance sheets that can... Those companies will do well, I think going forward.

Jonathan Forsgren:

Jason, what's your take on, what do you expect to see in the next 12 to 18 months related to inflation and interest rates?

Jason Chen:

Yeah, so I think the decision today, but really the last couple of months, call it, is a reaffirmation that even though inflation is coming down, like Danton just said, it is going to remain above what is called the Fed's official target. And what that means for interest rates is, I think there's another component to this that people often forget, which is not just short interest rates, but long term real interest rates are a function of monetary policy. So when the Fed engaged in quantitative tightening, that is probably not going to reverse in the foreseeable future. And what that means is from a discount rate standpoint, if you look at, let's say, the 10 year for instance, that real yield being pretty positive is something that is likely to persist, that's going to have implications for cost of capital. It's going to have implications for how you should discount cash flows.

Naturally, I just think this is going to be a consideration for companies in general when you have growth companies, albeit they have exposure to areas like AI, it's very compelling. But when you don't generate or earnings for a long time and you discount that at one and a half real for 10 years, that's a really challenging hurdle.

And so I think in the spirit of why international, that valuation discount, if we are at zero interest rates forever, perhaps you could justify that. But I do think international dividends and that thing look much more compelling, I think, with the outlook that rates will stay higher, particularly real interest rates will stay higher for quite some time. I think the other part of that is I mentioned currency carry as well. So for a while people are thinking that you would have this significant convergence between US rates and European rates, and even some people were calling for Japanese rates to go materially higher. That is the direction of travel. But it's being to be a lot slower than I think people anticipated, let's say three months ago. That differential between US interest rates and other developed market interest rates across the world is going to continue. And I think back to the point of hedging that currency risk, that is just one of many factors to consider, but it is, I think, to the benefit of people who choose to hedge that risk for the foreseeable future.

Jonathan Forsgren:

And finally, Rand?

Rand Wrighton:

Yeah, look, I would say first and foremost, we don't try to predict interest rates as we're predominantly bottom up value investors, but clearly we have to adapt to the current environment. And we don't think a 5% interest rate environment in the US is hardly unprecedented. We think that it's entirely possible, have a very healthy economy and growth runway with those kinds of costs of debt. We do think that it creates a tailwind for the value investment style. Obviously the present value of cashflow is affected by what discount rate you have and when you have businesses that you have a lot of the value in the tail of the terminal value that's going to obviously flow through versus other companies that have a lot near term cash return. And so I would echo the sentiments of both Danton and Jason around the importance of dividends, how this tilts the field in favor of those investments, and also raises that hurdle for businesses that have had effectively a zero cost of capital for some time.

And I think there's going to be a lot tighter focus on that. You're seeing pressure in those areas, and I don't think that's going to go away anytime soon. We do think that inflation should continue to broadly moderate over the next couple of years, but it likely will be a little stickier than most people think. We think that interest rates should start to come down globally towards the end of this year, but again, we think that could be slower than what people expect. So bringing that all together, we do think that companies that pay higher dividends that generate high free cash flow currently that are more value oriented, I think are a better place for investors to look right now versus where perhaps they should have been looking five, seven years ago.

Jonathan Forsgren:

Well, Danton, Jason, Rand, thank you very much for joining us today and sharing your insights.

Danton Goei:

Thank you.

Jason Chen:

Thank you.

Danton Goei:

Thank you for having us.

Rand Wrighton:

Thank you.

Jonathan Forsgren:

And to our viewers, thanks for watching. For Asset TV, I'm Jonathan Forsgren. We'll see you next time.