Secular growth trends in international equity markets
Despite bouts of volatility this year, U.S. equities, led by high growth firms have dominated global markets. Concerns over a global trade war and rising U.S. interest rates were headwinds for international equities. Looking beyond the macro headlines, the fundamental strength of international firms remains intact and is supported by attractive relative valuations. For further insight, we spoke with Carlos Garcia-Tunon, CFA, who serves as Portfolio Manager and Head of Fundamental Equity at MacKay Shields.
International equities have lagged, but are well positioned for future growth
So far this year, domestic equities have outpaced international and emerging markets equities by a wide margin. Much of the relative weakness outside of the U.S. has been exacerbated by a strengthening U.S. dollar and not necessarily corporate results. U.S. companies have also been the prime beneficiaries of a strengthening U.S. economy, tax cuts, and robust earnings.
Exhibit 1: Growth of a $10,000 investment (U.S. versus international equities)
Source: Morningstar, as of 8/20/18. YTD total returns of S&P 500, MSCI EAFE, and MSCI Emerging Markets (EM) indices. Past performance is no guarantee of future results. It is not possible to invest directly in an index. Individual results will vary.
The preliminary estimate for second-quarter annualized GDP growth in the U.S. was 4.1%—the strongest economic reading in nearly four years.1 Conversely, foreign economies are in an earlier phase of an expansionary cycle. Expectations for more interest rate hikes by the U.S. Federal Reserve have overshadowed strong fundamentals, thus putting downward pressure on foreign and emerging market securities.
Exhibit 2: Foreign economies are in an earlier phase of an expansionary cycle
Source: MacKay Shields.
More attractive valuations overseas
Economic and earnings growth outside of the U.S. has moderated, but remains healthy and is supported by attractive valuations based on several different accounting and financial metrics. According to Bloomberg estimates, international equity valuations are approximately 4% percent above their 10-year average whereas U.S. stocks are roughly 16% above.
Exhibit 3: At current levels, international equities are an attractive buying opportunity
Source: FactSet, as of 8/20/18. Price/Cash Flow, Price/Book, Price/Sales, and Forward P/E Ratio next 12 months earnings per share (EPS).
Disciplined investing with a focus on fundamental and secular growth trends
As is typically the case, there are issues that could impact global markets. An overly aggressive Fed rate policy, trade wars or slowing growth in China could crimp earnings, particularly within more cyclically sensitive industries. Against this backdrop, we believe individual stock selection will take on added importance. This includes not only identifying quality, secular growth companies that can withstand challenging conditions, but also entails avoiding companies with weak fundamentals that could be vulnerable if volatility increases.
Staying the course with sustainable growth companies
In our view, an appropriate investment strategy—especially in today’s market—is to focus on competitively advantaged companies with a history of sustainable growth backed by secular trends. We favor international companies with diversified business models and above-average earnings growth. These include demographic trends, such as a rapidly growing middle class in many developing countries, technological shifts, including the proliferation of online commerce and advertising, and business dynamics, such as outsourcing. Companies with these tailwinds at their back tend to be more resilient in challenging economic environments.
Actively diversify across the market capitalization spectrum
Investors can also exploit greater market inefficiencies by diversifying across international small- and mid-cap stocks which are often overlooked and underowned. Several smaller-sized companies derive a bulk of their revenues from domestic demand and as a result are less influenced by trade barriers and other macroeconomic headlines. Moreover, the number of sell-side research analysts covering smaller capitalization firms has been on the decline, thus providing a compelling opportunity to enhance risk-adjusted performance through disciplined stock selection.
Exhibit 4: Greater market inefficiency among small- and mid-caps
|Index||S&P 500||ACWI ex-U.S.||ACWI ex-U.S. Mid-Cap||ACWI ex-U.S. Small-Cap|
|Weighted Average Market Cap ($MM)||227,137||69,155||9,191||2,406|
|Average Number of Analysts Following Each Stock||26||19||13||7|
Source: MacKay Shields, as of 6/30/18. Past performance is no guarantee of future results. It is not possible to invest directly in an index. ACWI ex-US = MSCI ACWI ex USA Index; ACWI ex-US Mid Cap = MSCI ACWI ex USA Mid Cap Index; ACWI ex-US Small-Cap = MSCI ACWI ex USA Small Cap Index.
1. Source: U.S. Department of Commerce
The information and opinions contained herein are for general information use only. MainStay Investments does not guarantee their accuracy or completeness, nor does MainStay Investments assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. Such information and opinions are as of the date of this report, are subject to change without notice, and are not intended as an offer or solicitation with respect to the purchase or sales of any security or as personalized investment advice. There can be no guarantee that any projection, forecast, or opinion in this material will be realized.
All investments are subject to market risk, including possible loss of principal. Stocks and bonds can decline due to adverse issuer, market, regulatory, or economic developments.
Bonds are also subject to credit risk, in which the bond issuer may fail to pay interest and principal in a timely manner, or that negative perception of the issuer’s ability to make such payments may cause the price of that bond to decline. A bond’s prices are inversely affected by interest rates. The price will go up when interest rates fall and go down as interest rates rise.
Foreign securities can be subject to greater risks than U.S. investments, including currency fluctuations, less liquid trading markets, greater price volatility, political and economic instability, less publicly available information, and changes in tax or currency laws or monetary policy. These risks are likely to be greater for emerging markets than in developed markets.
Small and mid-cap stocks are often more volatile than large-cap stocks. Smaller companies generally face higher risks due to their limited product lines, markets and financial markets.
Index performance is shown for illustrative purposes only and does not predict or depict the performance of the Funds. Indices are unmanaged, include the reinvestment of dividends, and cannot be purchased directly by investors. Past performance does not guarantee future results.
Earnings per share (EPS) is the portion of a company’s profit allocated to each outstanding share of common stock.
Forward Price to Earnings (PE) Ratio is similar to the price to earnings ratio. While a regular P/E ratio is a current stock price over its earnings per share, a forward P/E ratio is a current stock’s price over its “predicted” earnings per share.
MSCI ACWI captures large and mid cap representation across 23 Developed Markets (DM) and 24 Emerging Markets (EM) countries. With 2,780 constituents, the index covers approximately 85% of the global investable equity opportunity set.
MSCI ACWI ex USA Index captures large and mid cap representation across 22 of 23 Developed Markets (DM) countries (excluding the US) and 24 Emerging Markets (EM) countries. With 2,154 constituents, the index covers approximately 85% of the global equity opportunity set outside the US.
MSCI ACWI ex USA Mid Cap Index captures mid cap representation across 22 Developed Markets (DM) and 24 Emerging Markets (EM) countries. With 960 constituents, the index covers approximately 15% of the free float-adjusted market capitalization in each country.
MSCI ACWI ex USA Small Cap Index captures small cap representation across 22 of 23 Developed Markets (DM) countries (excluding the US) and 24 Emerging Markets (EM) countries*. With 4,315 constituents, the index covers approximately 14% of the global equity opportunity set outside the US.
MSCI ACWI Momentum Index is based on MSCI ACWI Index and is designed to reflect the performance of an equity momentum strategy by emphasizing stocks with high price momentum.
MSCI EAFE Index consists of international stocks representing the developed world outside of North America.
MSCI Emerging Markets Index is an index created by Morgan Stanley Capital International (MSCI) designed to measure equity market performance in global emerging markets.
MSCI World Index is a free float‐adjusted market capitalization weighted index that is designed to measure the equity performance of 24 developed markets.
Price/Book Ratio, or P/B ratio, is a financial ratio used to compare a company’s current market price to its book value.
Price/Cash Flow Ratio (also called price-to-cash flow ratio or P/CF), is a ratio used to compare a company’s market value to its cash flow.
Price/Earnings Ratio (price‐to‐earnings or P/E Ratio) denotes the weighted average of all the P/Es of the securities in the fund’s portfolio.
Price/Sales Ratio, P/S ratio, or PSR, is a valuation metric for stocks. It is calculated by dividing the company’s market cap by the revenue in the most recent year; or, equivalently, divide the per-share stock price by the per-share revenue.
S&P 500 Index is an unmanaged index and is widely regarded as the standard for measuring large-cap U.S. stock-market performance. Index results assume the reinvestment of all capital gain and dividend distributions. An investment cannot be made directly into an index.
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New York Life Investments engages the services of MacKay Shields LLC, an affiliated, federally registered advisor, to subadvise several mutual funds. New York Life Investments® is a registered service mark and name under which New York Life Investment Management LLC does business. New York Life Investments, an indirect subsidiary of New York Life Insurance Company, New York, NY 10010, provides investment advisory products and services. Securities distributed by NYLIFE Distributors LLC, 30 Hudson Street, Jersey City, NJ 07302.