Over the past three to four years, easy money from accommodative monetary policies has fueled global market performance, despite poor fundamentals. These policies have kept interest rates extremely low, erasing the advantages the fittest companies typically derive from their strong balance sheets — as a bulwark against economic weakness and as an offensive tool to take advantage of stressed competitors.
As we enter 2016, the International and Global Growth team has seen a change in sentiment as the market anticipates interest rates eventually normalizing. Once this happens, we believe the advantage will once again revert to companies with less-levered balance sheets — and to strategies like ours that emphasize quality growth. However, that’s not what drives our decision-making — we’re much more concerned with what company managements are doing than central bankers. We are seeking to take advantage of the market volatility to purchase high-quality companies at attractive prices, an approach we believe can benefit investors with a long-term view.
Valuations improving
Due to the weakness in equity markets, valuations improved somewhat during 2015:
- The MSCI All Country Asia Pacific ex-Japan Index was trading at 13.1x its estimated price-to-earnings ratio for the next 12 months (P/E NTM) at the end of June. At the end of September, that fell to 11.7x – a drop of more than 10%1
- The drop in emerging markets, as represented by the MSCI Emerging Markets Index, was even sharper, with its estimated P/E NTM hitting 10.9x at the end of September1
- The estimated P/E NTM for the MSCI Europe index was 13.8x at the end of September1
- Valuations in all of these global regions were lower than in the U.S., where the MSCI USA Index’s estimated P/E NTM was 15.4x as of Sept. 301
Below, I highlight several areas that we’ll be watching closely in 2016.
Slowing growth in China spells opportunity for long–term investors
We continue to see a steady slowdown in economic growth as China digests years of excessive investments in property, industrial capacity and rapid credit growth. China is undergoing a transformation toward a more mature economy as it weans itself off of repeated government stimulus and dependence on export growth and instead focuses on a more sustainable model driven by a higher proportion of consumer growth.
The recent market turbulence was partly caused by weakness in the property markets, which meant less local government revenues to fund counter-cyclical spending and, in turn, had a negative impact on consumer spending. As corporations adjust to this “new normal,” earnings revisions are continuing to be negative.
With the market pullback in 2015, we found opportunities to establish new positions in China, particularly in the consumer staples space, as valuations became more attractive.
Brazil still lacks meaningful fiscal reform
In addition to sharply falling commodity prices, we believe President Dilma Rouseff’s interventionist economic policies since becoming president in 2011 have been a key factor in destabilizing the Brazilian economy, plunging it into a deep recession. Since her re-election, the president has tried to implement economic reforms – including the appointment of a market-friendly finance minister focused on fiscal austerity – but her lack of popularity and the recent “Operation Car Wash” bribery scandal involving state-controlled oil company Petrobras have hindered the adoption of a meaningful fiscal package. The recent resignation of finance minister Joaquim Levy and credit-agency downgrades of Brazil’s debt make a quick recovery unlikely.
Staying focused on quality businesses gives us conviction in this risky environment. We also believe valuations reflect Brazil’s current economic malaise, strengthening our conviction in our strategies’ weightings and positions in the country.
Finding opportunities in European quality cyclicals
At this time, we see more opportunities within quality cyclicals, as defensive stocks have become expensive after years of outperformance. During the sharp third-quarter market selloff, the Invesco International and Global Growth team added exposure within luxury goods and industrials.
Japanese companies deliver low-quality profits
Japan is one of the few countries where we saw positive earnings revisions in 2015, despite weak economic data. The reason for this dichotomy is the low-quality nature of the profits, meaning that many companies are seeing better top- and bottom-line growth due mainly to the weak yen rather than true improvements in underlying demand. While we remain skeptical of Prime Minister Shinzo Abe’s ability to implement significant economic reforms and structural changes, the initiative to demand better shareholder returns from corporate Japan is a welcome change.
Having said this, we continue to struggle to find quality growth companies at attractive valuations in Japan and have mainly been trimming our exposure in 2015 due to strong performance.
The three questions we ask about every stock
As always, bottom-up stockpicking, active management and a long-term investment horizon are the key drivers of our strategy. No matter the sector or country, we always ask three main questions when analyzing a stock:
- Is the earnings power sustainable through the investment cycle?
- Is the company financially strong and generating attractive returns?
- Is the stock attractively valued?
We have high conviction that our EQV stock selection process is the right approach for investors in the long term.
