Around The World In 5 Stocks

Joseph Hogue's picture

Tuesday, June 20, 2017 - 2:30pm

by Joseph Hogue

Even if you believe economic growth and corporate earnings will pick up, it's difficult to make the case that shares of U.S. companies are fairly-valued. Companies in the S&P 500 are expected to book earnings growth of 9.9% through 2017 according to analysts surveyed by FactSet Research

That brings the index's valuation to 17.7 times forward earnings, a premium of 26% on the S&P's average of 14.0 over the last decade.

Against this pricey environment, evidence has started to build that could disrupt the market. 

We've already seen the eight-year bull market waver, with the S&P 500 struggling to move higher through March and April. A few tech stocks managed to drag the market higher in May but investors seem to be getting skittish.

When the music stops on the second-longest bull market in history, the only investors left with chairs may be the ones that looked for growth outside U.S. markets.

How Long Can The U.S. Bull Market Last?
Just last week we got disappointing retail sales growth, and job growth has slowed this year compared to last. The Federal Reserve held to its outlook last week, withdrawing monetary support by raising rates and dismissing weak inflation data as temporary. That sets the stage for Yellen and company to meet their target of three rate hikes for this year and potentially start shrinking the Fed's balance sheet.

As the special investigation into the possible Russian meddling in the 2016 election grows, fiscal and tax reform seem further away. Congress has just five weeks until its August recess and still needs to address the debt ceiling and the budget, leaving no time for tax reform or other fiscal measures.

This isn't to say that the economy is at risk of coming to a grinding halt, but it doesn't have to for U.S. stocks to provide sub-par returns for the next year. If economic growth and earnings were to disappoint even marginally, it could take some steam out of investor enthusiasm. In any case, stocks could trade sideways until valuations come down to historical averages.

The solution? Look to investments untouched by the lofty valuations of U.S. stocks.

Investing In A Borderless World
The most obvious reasons to look beyond the red, white, and blue for investments are valuation and diversification. The SPDR S&P 500 ETF (NYSE: SPY) trades for 21.5 times trailing earnings against 14.8 times earnings for shares of the SPDR S&P Emerging Markets ETF (NYSE: GMM) and 16.9 times for stocks in the SPDR MSCI ex-US ETF (NYSE: CWI).

Granted, foreign and emerging market stocks generally trade at a discount to their U.S. peers, but the premium on domestic stocks has increased over the last several years.

As the Fed tightens and other central banks remain accommodative, economic growth in different parts of the world could diverge. The correlation of the emerging markets fund with the S&P 500, on a scale from -1.0 to 1.0, is a diversifying 0.74 while the MSCI ex-US fund is slightly more correlated with U.S. assets at 0.82.

That correlation could fall, providing even more diversification to U.S. assets, if economies start to go their own way as the U.S. struggles with tighter monetary policy. 

Foreign stocks offer much more than just cheaper valuations and diversification from U.S. assets. Investing in best-of-breed names abroad can also help balance sector-specific risks in the United States like slowing industry sales or increased competition.

Finally, if the greenback weakens on prospects for slower growth, shares of foreign companies will get a boost when their prices are translated into dollars for U.S. investors. 

While the 'conventional wisdom' typically recommends investing in regional indexes, i.e. emerging market growth or European stocks for stability, I like to look for promising names regardless of sector or location. 

This helps me diversify my U.S.-focused portfolio strategically by both sector and geography.

5 Best-Of-Breed Foreign Companies

Tata Motors (NYSE: TM) has a strong position in India and China, balancing the risks of slowing auto sales in the United States that are affecting investments in other car makers. Not only is the company a strong player in emerging market economy cars, but has been building a luxury brand through its 2009 acquisition of Jaguar and Land Rover.

Revenue for 2016 was reported down 1% due to currency effects. On a constant currency basis, revenue was up a solid 9% and passenger car sales surged 25% in its home market of India. Wholesale volume in China jumped 27% and the company looks like it has a long growth story ahead in the two countries. 

Shire PLC (Nasdaq: SHPG) has diversified its specialty pharma business with R&D and acquisitions in biologics manufacturing and rare disease drugs. Strong sales outside the United States could help shield the company if the Trump administration seeks to curb domestic drug prices.

The Dublin-based pharmaceutical company is already seeing strong growth in its immunology drugs, booking sales growth of 13% in the first quarter, after its acquisition of Baxalta in June 2016. The company also has a strong pipeline in treatments for rare diseases.  

Telefónica (NYSE: TEF) diversifies a portfolio of U.S. telecom names with a leader in Europe and Latin America. The $51.8 billion Madrid-based company has a controlling position in telephone services in Spain, wireless operations in Germany, and is the second-largest wireless operator in both the United Kingdom and Latin America.

Telefónica is leading the convergence trend in Europe and Latin America, bundling services of fixed-line, mobile, internet and TV for a huge competitive advantage. Revenue in the Latin American segment jumped 9.2% in the first quarter in local currency terms, even as subscriber growth was flat versus the same period in 2016. 

SINA (Nasdaq: SINA) recently announced another special share dividend of Weibo shares, the second distribution since October 2016. Sina is the leading online media company in China with Weibo, a Twitter-like social platform, quickly becoming a force itself. 

Sina will still control roughly two-thirds the voting shares of Weibo, along with Alibaba which holds 16% voting control. A position in SINA gives U.S. investors a big footprint in the future of online media in China.

Potash Corp of Saskatchewan's (NYSE: POT) planned merger with Agrium (NYSE: AGU) creates the world's largest agricultural nutrient company, combining the largest nutrient retail operator in the United States with the world's largest fertilizer manufacturer by capacity. The scale and retail distribution should drive pricing power and sales while cutting costs.

Fertilizer application rates in fast-growing China and India lag rates in developed markets. Increasing food demand in these markets should drive fertilizer demand growth for decades to come. Potash Corp is completing an $8 billion expansion project that will contribute easy volume growth as prices and demand increase.

Risks To Consider: Foreign stocks may come under pressure if the U.S. markets suffer a setback, even if fundamentals are relatively more attractive.

Action To Take: Diversify your U.S.-focused portfolio with relatively cheaper foreign stocks with strong fundamentals.

Editor's Note: From Russian gas & Saudi oil to the isolated cobalt mines of Central Africa -- the next decade will see the beginning of a global commodity "gold rush" unlike anything we've ever seen. Cash in the same way Rockefeller did over a hundred years ago...

Joseph Hogue does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.