Last month, we talked about why it makes sense for investors to include global bonds in their portfolios. Now, it’s time to discuss equities.
North American markets might be more wary, and growth stocks - that were so popular during the pandemic -, might have made a recent comeback in view of variant jitters, “but we still see the U.S. economy normalizing and reopening this year,” affirms David Sekera, chief market strategist at Morningstar. “There might be some limited instances of masking and social distancing, he continues, but we don’t see any lockdown on the scale of what we saw last year.”
“The U.S. and Canadian markets have done very well in the last year, and that performance is now priced in. Price-to-earnings ratios were extremely high at the end of May, standing at 32 times for the S&P 500 and 22 times for the S&P/TSX. Now, they have retrenched at 26 and 20 respectively, which is healthy, I think. Markets were pricing in all the optimism about reopening, yet when you looked at earnings, many companies couldn’t grow them,” says Alfred Lee, portfolio manager and investment strategist at BMO Asset Management
Follow the Vaccines
Morningstar believes that vaccine rollout and herd immunity will end the pandemic. Morningstar's Karen Andersen notes that COVID-19 will create a US$39 bn vaccine and treatment market and usher in immunity by 2023.
Vaccination is pacing the recovery, Lee highlights. Where it is extensive, as in the U.S. and Canada, the recovery is steaming along. But with time, it will spread to other countries and other regions, giving investors occasion to ride the wave and profit from it. But the way to go forward is not to try identifying countries that will move ahead. “It’s tough to go to any specific country at this point,” Lee notes. For example, Europe is very fragmented; vaccination rates and the status of lockdowns are very different from one country to another. “The pace of the recovery will vary widely, even in Asia,” Lee adds.
The way to go global is to invest in global stocks, Lee insists, targeting high quality companies that have a worldwide footprint, like Unilever, Apple, Diagio, Hermes, Novartis and Nestle. Such companies will take advantage of the growth in each market where they are present as the recovery picks up. At this point, international valuations outside North America are quite reasonable and leave space for value appreciation. Lee quotes the MSCI EAFE index, “the most widely referred international benchmark,” he says, where a present price-to-earnings ratio of 20.5 is very much in line with its historical average of 19.5.
“We allocate money on an industry sector basis, not on geography; and yes, that means going with global stocks,” agrees Drummond Brodeur, global strategist at CI Global Asset Management. Key illustrations of this strategy concern Europe and Japan. “I’m not keen on the European and Japanese economies where there is less ongoing growth to drive profitability,” he notes.
Japan, for one, has been dead for years, with a shrinking labor force and many economic impediments, Brodeur considers. However, key Japanese companies have global exposures in many different sectors, for example Fanuc, in robotics, and Keyence in sensors, and these sectors are fundamental to many industries that drive global growth. For similar reasons, Brodeur overweighs Europe, not because of economic prospects there, but because of the strong presence of global players among European stocks.
Weighing Canada
Overall, Brodeur favours cyclical stocks and relinquishes technology stocks, causing him to be underweight in the U.S., but overweight in Canada. Here, he quickly dispels a potential misunderstanding: being overweight in Canada only means being a bit over the 3% weight of the Canadian market inside the MSCI ACWI (All-Country World) index. Canadian investors “still stay too close to home,” he considers. He doesn’t advocate that they allocate only 3% of their portfolio to Canadian stocks. “Maybe they should have 25% or 50% of their portfolios in Canada, but the rest should be global.” Indeed, he recalls, “Canada has been a structural underperformer for the last decade or so,” which justifies minimizing the Canadian share of the portfolio. “When Canada outperformed, it was because of the higher concentration of financials and cyclical stocks,” which are presently doing well, and which explain the Canadian overweight.
Going global certainly doesn’t exclude a U.S. presence. But just as Brodeur under weighs that market because of technology, Morningstar’s Sekera advocates moving out of growth and technology stocks toward value stocks. “The growth stocks, thanks mostly to technology, benefited from the lockdown; now we see consumer spending shifting to services and consumer goods.” And that favours value which is presently more attractive. At the end of July, indicates Sekera, growth stocks were overall slightly above fair value, standing at 1.03, with the mid-cap and small cap sectors standing significantly above the fair value line at 1.19 and 1.09 respectively. At the same time, value stocks were below fair value at 0.96, small caps presenting the best fair value ratio at 0.92.
