Over the past decade, the U.S. stock market outperformed non-U.S. markets in eight of the last ten years. As a result, some question whether it still makes sense to invest in foreign companies. We believe it does! A global approach to investment management provides access to some of the world’s leading companies at particularly attractive valuations given their recent underperformance.
Almost half of the world’s value of public companies lies beyond our borders.
Companies listed on foreign stock exchanges represent 43% of the value of all publicly traded stocks. The five largest foreign exchanges are Japan, China, the U.K., Canada, and France.
Companies listed on these stock exchanges dominate sectors such as TV, cars, consumer products, and pharmaceuticals. Alibaba and Tencent are the “Amazon” and “Facebook” of China. If you are not investing globally, you do not have exposure to:
Taiwan Semiconductor – the world’s largest dedicated semiconductor chip manufacturer.
Alibaba – China’s online and mobile commerce company.
Nestle – the largest food and beverage manufacturer in the world by sales.
Tencent – China’s internet giant with investments in social networking and online games.
Samsung – the electronics conglomerate based in South Korea known for their TVs, mobile phones, semiconductors, and home appliances.
ASML Holding NV – the Netherlands-based leading manufacturer of photolithography systems used in manufacturing semiconductors.
Roche – the Swiss biopharmaceutical and diagnostic company.
LVMH – Paris-based luxury goods producer and distributor with brands such as Louis Vuitton, Bulgari, Fendi, Givenchy, Tag Heuer, Hennessy, Moet & Chandon, Glenmorangie, and Sephora.
Novartis – develops and manufactures healthcare products.
Toyota – one of the world’s largest automakers.
Many of these companies, while headquartered abroad, derive a substantial percentage of their revenues from U.S. consumers and companies. For example, Nestle’s U.S. sales were 31% of their 2020 global revenues, and Toyota operates ten manufacturing plants in the U.S.
Investing well requires buying future profits at a reasonable price.
Investment returns are determined by the price paid for future profits. Investing in a slow-growing company at the right price will likely generate above-average returns. Conversely, paying too much for the stock of a rapidly growing company will likely lead to mediocre returns. One of my mentors in investment management would remind me, “Lex, remember there is a difference between a great company and a great stock.” Great companies are defined by their customers, employees, products, and strategy. Great stocks are when future profits can be purchased at reasonable prices.
Today, it is generally cheaper to buy future earnings of foreign companies rather than those based in the U.S. As of the end of June 2021, the price for expected corporate earnings over the next year (the “P/E ratio”) is around 22 for the U.S., 16 for Europe and Japan and 14 for the emerging equity markets. A higher P/E ratio means that investors are assuming that U.S. companies are going to grow faster than their foreign counterparts. To beat the market, future earnings must exceed expectations. Given that investors have priced in lower growth for foreign markets, it will be easier for them to outperform.
In the past, there may have been some legitimate concerns regarding the quality of financial reporting and regulatory oversight outside of the U.S. While this remains a valid concern for mainland China and some very new emerging markets, it is not for the majority of foreign markets. Information transparency and quality improvements have been driven by increased global capital flows, improved training of professional investors, and convergence in accounting standards. In fact, GAAP (“Generally Accepted Accounting Principles”) in the U.S. and IFRS (“International Financial Reporting Standards”) abroad are equally robust.
The risks investing abroad are no greater than in the U.S., just different – which is a benefit.
A portfolio’s return is enhanced by seeking assets that fluctuate independently of each other. Stock markets around the world are not perfectly linked. Each is driven by a different mix of investors, companies, trade flows, and local economic factors. These differences provide a diversification of risks.
While investing abroad does introduce exposure to foreign currencies, the risk is mitigated by two factors:
- Major corporations generate profits in a variety of currencies. This is equally true for a company whose stock is listed on a U.S. stock exchange as it is for one listed on any other exchange. While the foreign stock may be denominated in another currency, their earnings are not necessarily in that currency.
- While the U.S. Dollar benefits from its current role as the world’s premier reserve currency, it will appreciate or depreciate in relationship to the other currencies. Global investing provides U.S.-based investors with a hedge against U.S. Dollar depreciation and is a better hedge than Bitcoin.
Another benefit of foreign markets is that they are less concentrated. The top ten firms listed at the start of this article only represent 12% of the total value of all foreign markets, compared to 24% for the top 10 in the U.S. Diversification improves risk-adjusted returns by reducing the impact of company specific events on the overall portfolio.
Avoid assuming the past will be the future.
While the U.S. market has outperformed other developed markets over the past ten years, that has not always been true. The graph below, from analysts at JPMorgan, provides a fifty-year view. It illustrates the relative performance of developed foreign markets, often referred to as “EAFE” ( Europe, Australasia, and the Far East), and the U.S. Purple represents periods when foreign markets enjoyed greater appreciation than the U.S. market. Clearly, there have been multi-year cycles of under and over performance. While we don’t know precisely when the current cycle will end (we don’t believe in trying to time markets), it likely will, and a new purple period will start.
Source: JP Morgan Asset Management
At HTG Advisors, our investment management philosophy is to invest globally and implement portfolios through cost-efficient funds. If you would like more information on how we invest or about our wealth advisory services, please email me at email@example.com.