The global and local sharemarkets may have retreated recently, but the global economic recovery continues to gather pace. So much so that the International Monetary Fund (IMF) recently raised its forecast for world economic growth.
The IMF predicts global growth of 3.9 per cent this year, up from the 3 per cent it forecast in October last year, and 4.3 per cent for next year.
Given this environment, what countries and sectors offer Australian investors the best opportunities offshore?
Firstly, areas that did well last year may not be the ones that will do well in the future. The recovery phase favoured cyclical and deep value stocks: those that went down the most tended to rebound the most. Given the low growth expected in much of the Western world, any company that can show decent growth will be bid up by investors.
As for regions and countries, I am finding more opportunities in emerging markets and I am also seeing opportunities in the US. While valuations in the Asia Pacific region looked relatively expensive, despite good growth prospects, I have taken advantage of recent underperformance to buy some few interesting holdings. In contrast, despite a number of recent trips there, I continue to find few opportunities in Japan.
Emerging markets posted some impressive sharemarket performances last year and some investors are wondering whether those returns can be repeated this year. It is a fact that some valuations are stretched and one needs to be very selective. However, emerging markets are part of a longer-term story that has much further to run and investing in emerging markets today is a very different experience to 10 years ago.
Companies in emerging markets are now better managed, more transparent and more focused on shareholder value. So much so that some emerging market companies are now global leaders. However, it is also worth bearing in mind that stocks listed in these markets are not the only way to benefit from the rising demand in developing countries. One can also invest in companies head-quartered in developed countries that realise a substantial part of their revenues in these markets, such as Carlsberg, which despite being listed in Denmark is actually a play on the growing Russian beer market.
In terms of sectors, I am finding more attractive investment opportunities in the materials, industrial and technology sectors. A lot of the fund’s holdings in these areas fit into the idea of likely revenue growth and incremental margins/improved return on equity. Materials stocks also constitute an inflation hedge, which could prove useful against the backdrop of government-led monetary expansion policies of recent times. A falling US dollar has also helped push up metal prices.
The technology sector, especially some companies in the US, offers robust balance sheets, healthy cash flows, experienced management teams and exciting new product cycles.
In contrast, I remain underweight defensive sectors such as utilities, consumer staples and health care. Valuations in these areas are not that compelling, particularly in light of the relatively muted growth prospects many of these businesses offer. The underweight in financials increased late last year, as some holdings in this area reached my price targets and I reinvested only a portion of the proceeds in the sector – primarily in property and stock exchanges.
It is not purely a matter of just identifying which countries and sectors are well positioned to benefit from particular themes, but more a matter of finding the best investment individual opportunities worldwide – businesses with the best growth prospects and valuations that do not fully reflect their potential.
In this challenging environment, my interest is in companies that have kind of a self-help story. This is where companies are being proactive in aggressively reducing both their fixed costs and their variable costs. I am likely to build positions in such stocks where valuations do not reflect improved profitability. I expect some of these firms to significantly overshoot brokers’ earnings estimates, as demand for products pick up.
My favourite companies are ones that have high and rising returns on invested capital, have great free cash flow and really have some kind of added value versus the competition. It may be new patents or a new product cycle or another competitive edge. I particularly like companies where management is really engaged and have their own money invested in the company themselves. This gives me conviction that management will act in the interest of shareholders. Overall, I want to own companies that have revenue growth, have done a great job on trimming costs and have the greatest opportunity to surprise on earnings.
Brenda Reed is portfolio manager of the Fidelity Global Equities Fund.
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