PM says with US equities at record high valuations, opportunity to own and capitalize on growth means looking beyond North America
As markets begin to open, after reeling from the effects of COVID-19, many investors and advisors are looking for areas of opportunity. For Matt Peden, senior portfolio manager with Invesco, that area of opportunity is in international markets.
“We are seeing better investment opportunities in the international space, particularly in emerging markets, like China, but also in developed markets like Europe and Japan,” said Peden. “It’s not a function of the underlying economic performance or the pace of openings, it’s more of a function of the speculative element in the US market, the betting on a strong recovery with the comfort that the FED will act as a backstop. The level of government stimulus programs has also been higher in the US than what we have seen in the European and Chinese markets.”
For Peden, who manages the Invesco International Companies Fund, he says those factors have resulted in a significant speculative environment in the US, that has even led to more retail investors participating through trading platforms. In turn, that has driven US equity valuations to less attractive levels. Peden says that high-risk companies are seeing more investment and, while they do offer potential upside, with the uncertainty around recovery, debt levels and a potential second wave of the virus, the risk is heightened.
However, that is not the case in other parts of the world. “I think we are seeing developed international markets at relatively full valuations, but more attractive than US. Likewise, emerging markets are where we are seeing the most attractive opportunities because of the continued trade tensions between China and the US,” said Peden. “In addition, there is a lack of speculative money flowing in because these markets are not as familiar to retail investors and not as easily enabled by free trading platforms.”
Another concern that Peden has with the US market is a potential for rising corporate and income taxes. “There is a very high likelihood of future corporate and income tax increases, and I don’t see that factored into the record high US market valuations at all. Internationally, it varies by country, but it is relatively not a major component.”
When it comes to areas he sees opportunity in, China quickly comes to mind because of the trade tensions but also less of an easy money policy that hasn’t inflated asset prices. When it comes to sectors, Peden notes that for his fund, they look at good quality businesses that have long-term potential. That doesn’t mean they will avoid a sector that was hit by the sell-off, but at the same time he says they aren’t looking to make a call on the timing of a recovery. Still, he does point to businesses in China that are offered at a lower valuation than their peers in developed markets. “When you look to China, we have large weightings in Alibaba and Tencent. Those businesses are stronger or comparable to Amazon and Facebook but trade at lower valuations and have better growth prospects based on the lower stage of development being in China versus the US.”
Peden does point out that since international and emerging markets are less familiar to North American Investors there are a couple of things they need to be aware of. “Traditionally emerging markets have been more volatile in terms of stock prices, particularly in Latin America. Then, there are some sovereign debt risks in developed European countries. In terms of price volatility, aside from Latin America, a lot of these large, stable businesses that we own in China, may not have the same degree of price volatility as they did in the past.
“Then, there is currency risk, this is clearly the case for the Latin American countries where there has been significant currency devaluations but also African countries like South Africa and Nigeria. China has been more stable in currency because of the size of the market and strength of central bank.”
Yet his own fund is an indication of the potential in international markets and a reason investors and advisors should look at the opportunity. It is in the top 2% of all international equity funds in Canada, with a 9.23% annualized return, having outperformed its benchmark 100% over five years. “It is really us acting consistently and focusing on identifying those businesses that are of high certainty, that we can understand, value and model for the next five or 10 years. Businesses that have a long growth runway so we can continue to own them at fair valuations knowing that the underlying value is compounding at a high rate over time.”