During a tour of duty for the United States Army Air Corps in World War II, Nobel laureate and economist Kenneth Arrow was asked to evaluate mathematical models to predict the weather one month ahead. He told his superiors that the models weren’t accurate. They responded: “The Commanding General is well aware that the forecasts are no good. However, he needs them for planning purposes.”1
Realizing that forecasting the near-term direction of global equity markets can be as difficult as predicting the weather, Charles Brandes looks at investment conditions not to forecast if markets are going up or down in the near term but to help us determine where value exists.
Our global perspective enables us to assess relative valuations around the world and see investment flows between regions, sectors and companies. These flows oft en create an environment where companies can be mispriced—sometimes to levels that are extremely low or high—and where valuations can diverge significantly from one market to another. Th is global perspective and our company-level research combine to serve as the foundation of Brandes’ portfolio construction process.
This quarterly commentary highlights our insights on key investment themes gleaned from company-level research, and which have driven recent portfolio decisions:
1. Europe and Emerging Markets: Conditions Conducive for Value Investors
2. Selectivity Is Key in the United States and Japan Following Broad-Based Gains
Europe and Emerging Markets: Conditions Conducive for Value Investors
Select European and emerging markets appear attractive to us, based on our company-by-company research, in part because declining share prices in these markets have created attractive valuations, as shown in Exhibit 1.
Charles Brandes – Europe: Opportunity Despite the Malaise
“We’re seeing attractive opportunities in Europe against the backdrop of continued concerns on euro zone economic growth as well as on how Greece and its euro zone neighbors will address Greece’s sovereign debt problems,” comments Jeff rey Germain, CFA, Senior Analyst, Brandes Investment Partners.
We believe value investing is oft en an eff ective strategy in that it periodically leads to areas of the world that have been written off at a macro level. Despite the tendency among many investors to paint the entire European investment picture as dark and foreboding, Brandes continues to see opportunity at the company level. As we analyze companies around the world, four features stand out that indicate solid value opportunities exist in Europe:
1. Attractive Valuations and Higher Dividend Yields vs. the U.S. Market
In Exhibit 2 (on page 3), the European market’s valuations remain fairly attractive to us, especially when compared to the U.S. market, as measured by cyclically adjusted price-to-earnings (CAPE).2 Additionally, Europe’s 3.3% dividend yield as of March 31, 2015, was higher than its own 20-year average, as well as 60% higher than the dividend yield on U.S. stocks as of March 31, 2015.3 Although dividend yield is not a primary criterion for how we select value stocks at Brandes, it can contribute to long-term performance.
2. Depressed Corporate Profits
Corporate profits in Europe were about 14% below their 10-year inflation-adjusted average.4 While depressed profits may appear to be a near-term negative, given our view that profitability is cyclical we believe the current situation presents an opportunity for long-term value investors. In our view, the current combination of low valuations and low profits could provide investors with an opportunity to benefit from potential capital appreciation if both measures revert toward historical averages.
3. Diversified Revenue Streams
Many Europe-domiciled corporations are quite diversified. For instance, European corporations derive about a third of their revenue from emerging-market regions,5 which represent 39% of global gross domestic product (GDP)6 and are forecasted to deliver over 70% of global GDP growth in 2015.7 Th e recent weakness of the euro has helped make many of these European companies more competitive with U.S. peers. A lower euro versus the U.S. dollar could, in time, provide a tail wind to profits for many European companies.
4. Signs of Progress
Austerity has helped balance primary budgets in the euro zone. Additionally, some countries have made progress on other structural reforms. In Spain, for example, these include pension reforms and streamlined government administration.
“Despite economic and political uncertainties in the region, our bottom-up fundamental research has led us to uncover a number of attractively valued companies in Europe,” Mr. Germain points out. “Companies that look particularly attractive include those in food & staples retailing and integrated oil & gas sectors.”
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