Growing attractiveness of non-US markets | August 2020



In this episode we discuss the growing attractiveness of non-US markets and large US technology stocks.

[0.27] We’ve talked in previous episodes about the strong performance from the large US technology stocks. Can you talk about what’s happened over the past three months?

  • After reaching a low on the 23 March, global equities (as measured by the MSCI All Country World benchmark index) gained 44%1
  • much of the rally was supported by the US market and its “FAAMG” growth stocks of Facebook, Apple, Amazon, Microsoft and Google
  • the secular growth story for the FAAMGs has been around for a while, but their group performance was supercharged by COVID-19
  • investors considered these stocks to be beneficiaries of government lock downs, as video conferencing (e.g. Microsoft’s Teams), social media and ecommerce use boomed while people worked from home
  • for instance, US June online retail sales surged by 23%1 from a year ago, gaining significant market share from physical shops, whose operations have been significantly disrupted by the pandemic.

[1.30] Do you believe there are risks to this outperformance looking forward?

  • Notwithstanding the risk over whether the online sector (e.g. Amazon) can maintain its current market share as economies are opened-up again
  • the market capitalisation of the FAAMGs has risen over $1.8tn so far this year, after rising $3.1tn during 2014-191
  • the rise in FAAMGs’ market value has far exceeded their $80bn increase in profits - to $159bn - over the 5 years to 20192
  • given that Facebook and Google already account for a third of global advertising spending, a key driver of their profitability, it may become more difficult to squeeze out further market share gains to boost future earnings2
  • the FAAMGs also face political risk from the US election in November
  • should the Democrats win a clean sweep of the White House, House of Representatives and Senate, it could lead to a regulatory backlash
  • ever-easier fiscal and monetary policy around the world increases the chance that GDP and Earnings Per Share (EPS) in other countries can catch up with the US and the FAAMG’s.

[2.50] Are there any other risks associated with the election?

  • There is also the added risk that corporate tax hikes under a potential Joe Biden presidency could halve US EPS growth (see our July Investment Outlook
  • under that scenario, investors would be likely to allocate more capital outside of the US where there is relative fundamental support and less risk of corporate tax rises
  • this view may already be playing out; after dominating equities over the past decade, the MSCI US benchmark index has underperformed the rest of the world by 4% since peaking on the 22 May1
  • on a risk-to-reward basis, we see investment opportunities outside of the US on less demanding valuations. For example, MSCI UK, Europe ex-UK and Emerging Markets trade on 2021 forward Price-to-Earnings (PE) multiple of 13.4x, 16.6x and 13.3x, respectively, as against 20.8x for the US1.

[4.09] It hasn’t been a great time for emerging markets, but do you believe valuations now look appealing?

  • The term Emerging Markets (EM) was coined by author Antoine van Agtmael in the early 1980s. Technical definitions vary, but generally an EM is understood to be a low to middle income per capita country transitioning to a more open market economy (e.g. China, Thailand or Brazil)
  • historically, EM returns have been volatile, but there have been long periods when EMs have significantly outperformed Developed Markets (DMs)
  • today, relative EMs valuations look attractive
  • EMs are assumed to entail more risk and generally trade at a discount to DMs, however, the EM 1-year forward PE ratio is 28% cheaper than DMs, below the historic average of a 23% discount.1

[5.05] Presumably China’s economic rebound is helping as well?

  • In the second quarter, China’s real GDP grew +3.2% from a year ago, higher than consensus expectations of +2.0% and up from a -6.8% contraction in the first quarter1
  • as the first economy to enter and emerge from COVID-19, China’s policy-supported recovery is driving demand for materials and consequently EMs through its large manufacturing base
  • further, China represents 39% of MSCI EM index so to a large extent the fates of EMs are entwined with China3.

[5.50] Finally, the Dollar has been under some pressure. Will this help emerging markets as well?

  • EMs tend to outperform DMs when the dollar weakens and vice versa
  • that’s because large quantities of dollar-denominated debt held by EMs is easier to pay back in times of dollar weakness
  • with record US money supply trickling into the global financial system, the US dollar trade weighted (DXY) index has fallen 9% since peaking in March1
  • the Greenback could depreciate further as rising US dollar supply is absorbed by foreign exchange markets
  • nonetheless, acute risks persist with emerging markets, with US-Sino relations somewhat frosty and COVID-19 is less under-control in some EMs (e.g. India and Brazil)
  • should FAAMGs and growth stocks consolidate at current levels, the conditions for a re-emergence of relative EM outperformance exist, and especially so in Asia.


1 Refinitiv Datastream, data as at 31 July 2020
2 Have Equities Become A Bubble?, Gavekal, 10 July 2020
3 Refinitiv Datastream, data as at 27 July 2020

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This episode was recorded on  29/07/2020

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The Pulse from Smith & Williamson

Investment Show: Growing attractiveness of non-US markets

Episode 12

Broadcast on Smith & Williamson at 09:00, 29th of JULY 2020

Available online from 10:00 on the same day .

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