Overseas Managers Keep Faith in Fundamentals
As macroeconomic issues whipsaw the markets, bottom-up stock-pickers roll up their sleeves.
Significant global headwinds have beleaguered markets across the world in 2010. The rising Japanese yen, persistent concerns over repercussions from the European sovereign debt crisis and the consequent austerity measures, and weak economic data from the United States have sent global investors into sell mode.
During the last six months, Japan's Nikkei and China's Shanghai Composite have dropped 15.5% and 14.6%, while Britain's FTSE and France's CAC have fallen 2.3% and 6.5%. Meanwhile, the S&P 500 has slipped a more moderate 2.4% during the same time, recovering from a sharper drop immediately following the height of the European crisis. As investors fled the equity markets in search of a safe haven, there was a sudden surge in gold and silver prices, further revealing a pervasive nervousness.
As markets seem to be taking their cues from discouraging macroeconomic themes, investors' focus seems to be shifting away from company fundamentals, as argued in a recent Wall Street Journal article.
"People are afraid to stay focused on the fundamentals, so they are going to the macro," says Oakmark International (OAKIX) fund manager David Herro, who Morningstar named its International Stock Manager of the Decade earlier this year. "The problem with that is the macro changes like the wind; it's like the weather. There are so many variables, there are unstable coefficients, and people get whipsawed."
On the flip side, for those willing to focus on fundamentals, the market's macro-induced mood swings can create compelling buying opportunities among individual names. For instance, Herro says negative macro conditions in Europe led to a brutal 15%-plus sell-off of Spanish bank Banco Santander (STD) in 2010, despite the fact that the company gets less than a third of its revenue from Spain--one of the European nations caught up in the crisis.
"A lot of the firm's profits come from Brazil, Mexico, the United Kingdom, and even to some degree the United States," Herro explains. "But what we've seen is because of the weak macro conditions in Europe, people all of a sudden just want to flee European financials, without even looking to see where these companies actually earn their money."
Similarly, fund manager James Moffett of Scout International (UMBWX) says his fund's strategy in Europe is focused on issue selection. "There are stocks we like," he says, including Inditex (the Spanish firm behind fast-fashion chain Zara), and Italian eyewear giant Luxottica (LUX), which are export-oriented, multinational companies that are not completely dependent on the local market. Both were listed among the fund's portfolio holdings as of Aug. 31.
However, Moffett says the fund is underweight on European banks over lingering concerns about the stress tests and stability of the financial system. "We are still worried about that� because we think that there are still other shoes to drop for that centipede," Moffett says.
Franklin Mutual Advisers' Philippe Brugere-Trelat, portfolio manager of Mutual Global Discovery Fund (TEDIX), also says that many European corporations with strong operational performance, good management teams, and solid balance sheets "have been unfairly punished by market circumstances" and are "trading below our estimates of intrinsic value."
"In addition, given the significant contribution that exports make to the region's gross domestic product, core industrial Europe is a clear beneficiary of a depreciating currency that makes its products even more competitive on world markets," Brugere-Trelat says. "We have both added new companies, and added to some existing positions, that benefit from a weaker euro, such as Siemens (SIE), Daimler (DAI) or Schneider (SU)."
Moffett has also added to internationally-oriented industrial exporters, but some of his picks are based in Japan, such as electronic equipment maker Kyocera (KYO), the world's second-largest construction-equipment maker Komatsu (KMTUY), and robotic maker Fanuc (FANUY). He has increased his fund's weight in Japanese companies to 14% from about 10.5% earlier in the year.
"There is somewhat also a yen play [in these investments]," Moffett says. "Unfortunately, the yen hasn't gone our way in the short run, but we think these are quality companies. And some of them are multinational in the sense that they are doing the same thing we're doing, where they are outsourcing manufacturing to China and Southeast Asia."
Back Door to the Emerging Markets
As investors have fled the European continent and concerns have mounted about the debt loads of developed nations globally, funds continue to flow to emerging markets, whose fundamentals--both balance sheet and economic growth--can look quite attractive by comparison. Indeed, the diversified emerging-markets and emerging-markets bond fund categories are each up more than 14% for the year to date. But their popularity has also raised some flags on the valuation front.
"One of the areas that is probably overvalued on a relative basis are the emerging markets," Moffett says. "Ten years ago, they were very depressed in their valuations, and now they are relatively high. Their prospects, in a sense, aren't a whole lot better or worse than they were 10 years ago; it's just that people appreciate them now. So we're a little more cautious on the emerging markets because of that at this point."
Moffett would challenge the assumption that growth necessarily equals good investments. "Europe is sleepy, old growth," he says, "but [those investments] provide good, risk-adjusted returns. Whereas in some of the emerging markets, that's where the sizzle is. But the valuations aren't there, or the ability to convert that growth into actual profits in some cases is challenging."
Moffett, for instance, prefers indirect exposure to China using raw materials and energy investments as well as positions in Korea, Taiwan, Hong Kong, and Singapore as a way to play Chinese growth. "One of the criteria we use is the Heritage Foundation's Economic Freedom Index," he says. "[China is] way down the list in terms of contract rights and government controls."
"During the next five years, we expect the global economy will experience demonstrably greater growth contribution from the emerging countries than from the developed regions," Ketterer says. "The vast majority of the companies represented in Causeway International Value are expanding their sales and profits in the emerging countries to exploit this growth difference. For example, capital goods represents the single greatest industry weight in the fund, and many of those capital-goods companies benefit directly in global aviation expansion, in Asia and the Middle East, in particular. We expect these fund holdings to benefit from the rise in wealth and the increasing propensity to travel in the developing countries."
As the global markets have gyrated in 2010, the international managers have in response been more active, too.
Oakmark International's Herro, against the fund's more typical lower-turnover behavior, has been buying back some of the stocks that he had trimmed in the third and fourth quarter of 2009 because of dramatic price movement.
Some stocks that had an upside of about 150%-200% suddenly saw that drop to 50% or 60%, he says, which persuaded him to sell in 2009 and early 2010. But after sovereign debt fears triggered price fluctuations yet again, Herro bought into the weakness.
"In our view, not much has changed in terms of the fundamentals," he says. "We have to act. We have to continually position the portfolio such that our money is weighted in those stocks that have the highest expected rate of return."
Ketterer says she has been buying during market weakness this year, especially increasing the stake in Europe's banks while the markets were grappling with the sovereign debt crisis that threatened the eurozone's fiscal health.
Mutual Global's Brugere-Trelat also says he has been a fairly active buyer during the past year and has been partial toward good companies with strong balance sheets. He says his fund has found opportunities among large European companies that "derive a significant portion of their top-line earnings from regions that are enjoying stronger economic growth, namely North America and, of course, Asia."
Looking ahead, Scout International's Moffett is optimistic about the latter part of the year. "Our attitude is going up," he says. "We think that the fourth quarter is going to be pretty good." Moffet notes that some of this optimism will be driven by the U.S. market after the uncertainty around the midterm elections dissipates.
Anuradha Ramanathan does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.
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