By Elisa Mazen
In the latest Legg Mason Global Investment Survey, now in its sixth year, 66 percent of U.S. investors expected U.S. equity markets to rise over the next 12 months, with 29 percent predicting a significant increase. U.S. investors had the highest home bias of any country we surveyed, with 73 percent seeing it as the best market for return opportunities. This is despite mounting concerns over healthcare costs, trade wars and potentially rising U.S. and global inflation.
Yet despite its long economic boom, the U.S. is not the only game in the world for companies with potential for rapid growth. Europe and Japan are recovering from years of economic stagnation. We believe markets have already baked in potentially destabilizing political news from eurozone countries such as Italy and Greece. In addition, industries from robotics to green technology are more advanced outside the U.S.
International stock plays are timely now because international markets have underperformed the U.S. market. We believe this underperformance derives from currencies rather than economic factors. Going forward, these currencies should mean-revert to their normal trading ranges, driven by a reduction in the difference in interest rates between the U.S. and other countries.
The outcome could be a lift-off to these offshore currencies and foreign market performance in general.
Owning U.S.-based multinationals offers global exposure, but without the cyclical and correlation benefits of direct non-U.S. investments. The U.S. is further along in its economic and equity market expansion, and prices reflect that: buying U.S. companies means buying U.S. multiples.
International equities may be a cheaper way to get international exposure since U.S. markets are very well understood, and maybe overly so: there are very few mispricings in a comparatively efficient market. But foreign markets can offer greater possibilities to find under-valued stocks.
These macro trends provide a favorable backdrop, but to identify specific opportunities, investors must drill down to the company level.
As international investors, we separate growth stocks into three different categories: structural, secular and emerging. The potential of structural growth stocks has yet to be recognized by the market and they may trade at a discount. Secular growth companies are often stable, established companies with superior business models. Emerging growth stocks are international franchises in the process of breaking out to widespread expansion. This three-bucketed approach offers diversification and aids in identifying interesting growth stories missing from a more conventional framework.
Having a good growth story is important, but at what price? Alpha is more reliably generated when starting from lower valuations, which means digging into the fundamentals of companies poised for growth. Quantitative factor-based models that incorporate several factors including quality, valuation, earnings, earnings revisions and price momentum can also be deployed to help identify companies poised for consistent growth over the long term that are also trading at attractive multiples today.
Getting it right means compounding above the market for a long time. That’s winning.
British pest control company Rentokil is a perfect example of a company that successfully fits in the aforementioned approach to international growth investing.
The stock is inexpensive, and earnings are growing. Although hardly in a glamorous business—killing bugs and rats—it is quickly growing in international markets such as India, in both the business and residential sectors.
It is also benefiting from a secular shift in these countries to focus more closely on health issues. As emerging economies develop and their restaurants, hospitals and schools become more conscious of hygiene, pest control could be a very good long-term growth business.
The goal is not to chase macro trends, but to find and hold solid, growing companies for long periods. While hardly novel, we believe this approach can succeed in any market, anywhere in the world.
Elisa Mazen is the head of Global Growth at ClearBridge Investments, a subsidiary of Legg Mason. Her opinions are not meant to be viewed as investment advice or a solicitation for investment.
