A strong dollar is great when you’re on vacation in Europe because your money goes a long way. But bargains on foreign goods and services aren’t the only advantage: investors can also pick up bargains if they know where to look.
Foreign markets are particularly attractive now that the US stock market is heavily concentrated around big names and AI beneficiaries. Hypertension may have pushed much of the U.S. market into expensive territory that may soon run out. Asset manager GMO, founded by Jeremy Grantham, forecasts absorption of roughly 1% in US large-caps over the next seven years. High value stocks are expected to collect gains of 7.6%.
So far, relatively cheap foreign currencies, combined with parts of the global market that have been left behind, have created a spread between expensive and cheaper stocks that is greater than 98% of history. This has resulted in the best relative opportunity for asset allocators in the 35 years since GMO’s global asset allocation strategy has been in place, said Ben Inker, the firm’s co-head of asset allocation. On Wednesday, the Japanese yen fell to its lowest point since 1990.
“Everybody knows that growth stocks in the U.S. are down quite a bit,” he said. Meanwhile, US value stocks have become well priced. Comparatively, European growth stocks also performed well, as a handful of high-quality names such as ASML and Novo Nartis caught the attention of investors. But they also trade at large premiums, while their deep-value European peers have largely been left behind.
“We’re seeing a lot of lower valuations in companies that are really benefiting from the fact that the dollar has been strong and therefore currencies like the euro and the yen are really undervalued today, which gives a real leg up to companies whose costs are in those currencies,” he said Inker.
Broad non-U.S. index prices are delivering returns that are at least as good as long-term stock market averages of 7% to 9% annually, he noted. But for better returns, investors should focus on high-value European stocks and small-cap Japanese stocks. They cost twice the normal return on capital, or between 12.6% to 12.8% after inflation.
In Japan, the market is doing well thanks to foreign investors who tend to buy names they know, such as Toyota and Honda. Smaller-cap Japanese companies were largely overlooked. Yet some of these smaller names are the backbone of industries that create products that are highly relied upon and require specialized expertise to produce. Examples include marine paint, coatings for computer chips and certain auto parts, he said.
“As a long-term investor, the way you really make money is from the cash flows of the companies,” Inker said. “And what we’re seeing in the case of Japanese small-cap companies is that they’re more focused on paying out their profits and dividends, buying back shares, consolidating and buying companies that shouldn’t be independent, through mergers and acquisitions activity. We’re seeing a lot more of that than we’ve seen in the last three or four decades.”
The underlying principles that lend themselves to the prospect of returning cash to shareholders are in place. And that’s a strong argument for them over the next three to five years, he noted. However, investors only get excited about these things after their returns are pretty good, and many Japanese companies don’t pass on profits to shareholders. But management behavior around it is changing, and that’s what’s most exciting about this market segment, he noted.
The graph below presents the projected return on GMOs over the next seven years.
GMO 7-year outlook for euity.
GMO
While it can be difficult to browse individual stocks, getting a portfolio of non-US stocks at very attractive prices is much easier than it used to be. Investors can look for mutual funds and exchange-traded funds (ETFs) focused entirely on stocks in foreign sectors, Inker said. For example, the iShares MSCI Japan Small-Cap and the iShares Edge MSCI Europe Value Factor UCITS ETF track the themes discussed by Inker.
It’s also worth recognizing that cheaper value stocks aren’t the only exciting thing about investing in today’s market. Bond yields and cash in money market funds and CDs are much higher than they used to be. That means there are more ways investors can get decent returns without being pushed into the riskier parts of the stock market, he noted.
