International equities opportunities amid the confusion

While the outlook for international equities remains confused by events in Europe, Damon Taylor writes that a number of managers believe the ongoing confusion is also creating opportunity.

If evening news bulletins and morning newspapers are any indication, the turmoil in European economies is clearly on investors’ radars.

Like it or not, dysfunction in Europe has had a ripple effect on all global markets, but the reality, according to Amit Lodha Portfolio Manager for the Fidelity Global Equities Fund – and one investors must keep firmly in mind – is that the global equities story is about much more than Europe.

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“The basic point here is that we’re talking global equities, global markets, and that means that isn’t all about Europe,” he said.

“Europe is only about 12 to 15 per cent of the global market in terms of GDP [gross domestic product] and market cap, and companies which are domiciled in Europe may not necessarily sell in Europe alone.

“Realistically, everyone knows the bad news out there, everyone knows that Europe remains a big risk and that no-one has a really good solution in the near to medium term,” Lodha continued.

“So what that means is that you should basically plan for recession in Europe for most of 2012 and maybe part of 2013, and that is the way most companies – most equity market participants – have planned within their business.

“The point here is that most of the bad news that you read in the newspapers every day is, in my view, already reflected in the equity market,” he said.

In fact, Lodha’s is a common view among global equities fund managers. In the current global environment, the key themes are consistently identified to be market movements in Europe, the United States and China, but for William Davies – head of global equities for Threadneedle Investments – there are still grounds for optimism.

“Those are the three main topics at the moment, and they’re couched with a negative tone, but we believe there’s more to it than that,” he said.

“Moving past Europe, if we now look at the US, the US saw quite strong growth around year-end – stronger than most people would have thought.

“As we moved into the first quarter, it continued to be stronger than people thought,” Davies continued.

“Now part of that was due to the mild winter and the fact that construction didn’t slow as much as it normally would, but it’s also related to the fact that the quarter was seasonally adjusted.”

Davies admitted, however, that the US budget deficit remained a key concern.

“The budget deficit is a concern and that’s got to be tackled when we have either a new President or the same President in a new term,” he said.

“It will require significant deleveraging, but the bottom line – if we look at the US economy as a whole – is that it’s not growing strongly, but it is growing at around that 2 per cent plus rate for this year.

“It’s not great growth, but it’s growth – and it’s a good deal better than the Eurozone,” Davies said.

On the emerging markets side, Lodha suggested that China was of most interest, but that India and Africa were also important.

“If you take China, I was in China two weeks back and I think growth is definitely slowing, but you could say that they have a lot of levers to pull to restart growth,” he said.

“So a lot of the growth slowdown is managed to control inflation, and that seems to be the case in India as well.

“In recent years, inflation has been a problem in both these economies, but the policies that they put in place last year were aimed specifically at slowing growth down this year, which is almost exactly what you’ve now got,” Lodha added.

"These are markets which are also able to restart growth and I think we’re starting to see the early signs of that coming through."

“However, these are markets which are also able to restart growth and I think we’re starting to see the early signs of that coming through.

“So what that means is that for these economies, 2013 will be pretty positive. And I don’t think that’s appropriately discounted by the market at this point in time,” he said.

In fact, if taken as a whole, Clay Carter, head of international for Perennial Investment Partners, said there may even be opportunity in some of this global markets dysfunction.

“It’s unfortunate that markets are reacting to headlines, which are risk-on one day, risk-off the other,” he said.

“They’re ignoring a lot of the more positive fundamentals out there, so I would think that if you’re an Australian institutional investor – or even a retail investor – you’d have to look at where the Australian currency is and realise that, with its current strength, there’s an obvious opportunity.

“But I think you also have to take a bit of a contrarian approach and realise that the Europeans will muddle through,” Carter added.

“Then, probably in the second half of the year, markets will come to their senses to some degree and put on a pretty decent rally.”

So despite the Eurozone crisis and its flow-on effects on other foreign markets, the clear consensus is that on a long-term basis, opportunities remain. Indeed, Lodha believes stronger global equities allocations by Australian superannuation funds are long overdue.

“There’s no doubt that Australia has had a phenomenal 10 years, but that growth story has coincided with the emergence of China as a global growth engine,” he said.

“The demand from China for infrastructure, and therefore the resources boom that you’ve seen, has meant that Australia could not help but be well-positioned for growth.

“From a tactical perspective, the Australian market has done extremely well and so there has been very little reason for an Australian investor to drastically change their allocation to invest more globally,” continued Lodha.

“But the point I’d make is that while all of that is true, it is also very clearly the story of the last 10 years.

“The story for the next 10 years – at least from a Chinese perspective, which is very important for Australian investors – is likely to be very different,” he said.

For Lodha, the Chinese have indicated quite clearly that they will retool their economy towards consumption, and it would be in Australian investors’ best interest to take notice.

“You don’t have too many Australian listed companies which gain from that growth in consumption,” he said.

“You take the internet boom, you take all of what’s happening in technology – there’s just not many Australian companies experiencing that boom.

There’s no need to rush in and sell all your Aussie equities, but there is a case to be made for continuing to reweight your portfolios in that direction.

“And I think that’s the point for the global investor – there’s a lot more happening in the world, which you simply don’t get to play in as a purely Australian investor,” he said.

Seeing a similar need for the gradual reweighting of portfolios away from superannuation funds’ traditional home country bias, Davies said that while he well understood investors’ recent caution with respect to global equities markets, it could not last forever.

“If we look at the last half year or even longer than that, there’s been very little commitment to global equities from Australian super funds,” he said.

“So what is happening is that there is cash or liquid assets that are building up.

“However, the one thing which I would point out is that it’s going to be very difficult for everyone to accurately pick a bottom within markets,” Davies continued.

“So what we would say is that you don’t commit everything right now in ‘one fell swoop’, but we do think it’s wise to dip your toe in.

“You want to have a policy of putting some money into global markets on an ongoing basis, because if markets do turn, you don’t want to miss out,” he said.

Echoing Davies, Lodha reiterated the need for Australian superannuation funds to re-examine their current global equities allocations in what was likely to be a very different economic and investment landscape globally.

“There’s no need to rush in and sell all your Aussie equities, but there is a case to be made for continuing to reweight your portfolios in that direction,” he said.

“You want to play that growth story and realise that the sun is setting on the fixed asset investment story in China.

“It will still be strong, but the rate of growth isn’t going to be as fantastic as it’s been over the past few years.”

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