International equities: Do they remain a key driver of returns?

When building its portfolio of 30 stocks across 16 global megatrends, Insync looks for businesses with sustainable earnings, which ultimately drives the share price over the long-term. Monik says if investors can focus on finding businesses that are highly profitable, can deliver sustainable earnings, and have strong megatrends fuelling their growth, then they’re likely to do well with their investments.

“If you have a portfolio of companies that have high levels of profitability, return on capital, high net margins, are debt-free, and have strong cashflow generation that are linked to a megatrend, then we believe these are the types of companies that will thrive in what will continue to be very uncertain times.”

Two examples of megatrends include:

* The silver economy – An ageing global population, with the number of people over the age of 55 expected to double to around two billion people within the coming decades. The demand for products and services to address issues like chronic diseases for this demographic will continue to accelerate.

* Pet humanisation – This is a long-term secular trend, where people are increasingly treating pets as humans, with overall spend growing at 3x GDP. Companies operating in this space have increased their sales by 45 per cent over the last two years, despite continuing market volatility and uncertainty.

“Secular growth companies with high levels of profitability are relatively well positioned in an environment of higher inflation, high interest rates and slowing economic growth,” says Monik. “These types of companies can be found in megatrends.”

Rob Makdissi — Investment Manager at Akambo — believes there is value in global equities, although he accepts there will be challenges moving forward, including market volatility.

“We believe there is value in certain sectors and regions of the world. But we do think we’re entering into a more challenging and volatile period,” says Rob. “So, against this backdrop, when it comes to investing in equities, always look at the value you’re buying, your growth expectation, and remember not to assume that your expectation for growth will continue indefinitely.”

When looking at the global equities landscape, one of the disconnects Dominic McCormick — Investment Consultant — sees with portfolios is how heavily weighted they still are to large cap growth tech stocks. Instead, he believes investors should be looking beyond this sector at the many other different opportunities available to them.

Rob agrees: “If I was asked to buy something today, I’d buy value. I think there is value outside the U.S. in particular sectors. However, the reality is a lot of companies and sectors don’t have the sustainability of earnings that the market is currently pricing in. So, that’s something to be aware of.”

According to Monik, investors need to consider the structural macroeconomic settings when they’re looking at stocks and businesses. He says understanding secular factors are very important. For example, for certain capital intensive and value sectors to work well, they need low interest rates and rapidly rising real economic growth. However, that’s not the environment we’re currently in.

“It’s very easy to keep on going back to valuation, and it does work from time to time when companies have another great year. But you really need to understand the structural and secular forces at play when you’re looking at picking sectors and stocks,” says Monik.

A macro issue currently playing out in the U.S. that Ashley Owen, CFA — Director and Founder of Owen Analytics — believes investors should be aware of is the continuing disruption caused between very tight monetary policy and very loose fiscal policy. He believes these unaligned policies do create a challenge for markets going forward.

“As analysts, we look at stocks — like Apple, Microsoft, and Tesla — from the bottom-up in terms of their earnings and profit. But you need to look at the macro environment as well,” he says.

As an example, Ashley refers to total global profits, which were $2.9 trillion in 2019 and $1.7 trillion the following year. But in 2022, total global profits jumped to $3.9 trillion. Despite rates going up from zero to 4 per cent, this additional $1 trillion, compared to three years previously, came from monetary stimulus.

“And while we now have tighter monetary policy in the world, the fiscal policy of giving companies and people free cash — which is mostly now only happening in the U.S. — went straight to bottom-line company profits,” says Ashley.

With a great deal of stimulus money still moving about within the global economy, the 2023 macro forecast for global profits is around $4.4 trillion. That’s another half trillion dollars that’s going to be booked in as profits by companies compared to last year.

Ashley says it’s ironic that global economies are in a spending slowdown, whilst company profits are “through the roof”.

“If you look at U.S. reporting in July, as well as in Europe and particularly Japan, profits are through the roof. These profits are largely coming from fiscal stimulus — mainly from the U.S., but also from Europe and China,” he says.

“Is that going to stop? I don’t think so, and for a number of reasons, like the capex required for the transition to renewable energy and for social housing. We’re going to see stimulatory policy in a number of countries for some time to come. This will be good for company profits, which underpins share prices.”

Rob agrees, adding that fiscal policy is driving profit and earnings growth. “Despite generally tighter monetary policy around the world, we’re continuing to see further stimulus packages from governments.”

He points to last year’s Gilt crisis in the U.K., when markets bottomed, as well as the emergency lending program implemented earlier this year in the U.S., when markets dropped in response to the Signature Bank and Silicon Valley Bank crisis.

“To deal with these crises, we had a lot of stimulus come through from central banks, like the Federal Reserve’s Bank Term Funding Program (BTFP) in March 2023.”

However, the big question for Rob in terms of where interest rates go, is whether governments can continue to provide financial stimulus packages going forward. Ultimately, he believes what will stop them will be the bond and/or currency markets.

“Currently, the United States is in a relatively privileged position, due to the strength of the U.S. dollar and its ability to raise funds. However, what happens if the U.S. does go into recession and additional stimulus is required, and how will the bond market react? There is a limit to how much stimulus governments can continue to push through.”

This year, some sectors and regions, like Japanese equities, have performed better than expected, offering investors attractive valuations. Monik believes there is a strong case for investors to reassess their exposure to Japanese equities, although he notes that the Japanese market is still below the highs it reached in 1989.

“There are some positive actions happening in Japan in terms of capital allocation and trying to improve the return on capital, which we believe is a big driver of equity prices over the long-term. That’s a good thing, because if you get positive changes on return of capital, then that typically leads to better share price performance. So, with these positive actions, I think Japan is probably a good place to be.” 

However, Ashley has a more cautious view on Japan.