International markets ripe for the picking

Australian investors have been scrounging amid poor investment fare for some time — direct property being the notable exception. With the doomsayers predicting the bursting of that bubble, it is no wonder that the Australian dollar’s strength is persuading some investors to look offshore for attractive pickings.

Of course, until now the rest of the world’s economies and their companies have been faring no better, and in most cases were worse off, than the Australian market.

But the past three to four months have seen a change in sentiment.

US economic data and some notable positives in corporate earnings reports have had commentators reaching into the literary closet to dust off and parade the phrase ‘bull market’ once more — albeit that the forecast of modest two to three per cent US gross domestic product (GDP) growth for 2003/04 would produce a paler, far less natty version of the bull market last seen turning heads in 2001.

Major money markets such as Germany and the UK have shown consecutive months of growth — hinting at a turnaround.

But the consensus is caution — so where does real value lie?

According to Garth Rossler, director atMaple-Brown Abbott, “on an international basis the markets have come off a long way, but that does not necessarily mean they are cheap”.

As a value investor, Maple-Brown Abbot selects investment managers that look for stocks with a good relative combination of low Price/Earnings(P/E) multiples, a positive industry story and acceptable sovereign risk and related variables.

Rossler says the recent shifts in Australian dollar strength and overseas market indicators have seen his firm shift its exposure to international funds from underweight to neutral.

“Our favourite region remains Asia… our view on the US is that it is still relatively expensive although there are still some good value stocks in that market.”

In the Asian markets, financials and manufacturing/industrial stocks are in favour, as opposed to tertiary sector stocks.

One of the quandaries facing cautious investors at this time is the apparent dual mindset illustrated by US equity and bond markets.

In the past two months, both markets have priced in an essentially contradictory reading of future trends — with equities values increasing based on optimism for a slow, steady recovery in the US economy in the next 12 months.

At the same time, the US Federal benchmark interest rate is currently at a recent historic low of 1.5 per cent, with the market pricing in the possibility of a further 25 basis point reduction.

Regarded as a tool for managing economic activity only — the interest rate is not necessarily a cause for concern — but seen from an absolute viewpoint, such a low rate is an indicator that the US economy is at one of its lowest ever ebbs.

Rick Barry is a senior vice-president in the Singapore office of Acadian Asset Management — a Boston-based specialist in emerging markets.

Barry says his firm agrees with the consensus of a mild global upswing and that the US is overpriced as a rule (although there are US stocks that are not part of the major indices at good value).

Instead, his firm likes the Philippines and Thailand of the Asian emerging markets, and Colombia in South America.

Most importantly, according to Barry, investors should focus on the historically low P/E valuations for emerging markets.

These he says are “in low double-digits — in some cases even single digits — which indicated that there are some highly attractive valuations on a fundamental basis”.

According to his firm’s in-house modelling, emerging markets will return 12 per cent per annum on average during the next five years, as opposed to the US S&P500, which will return six to seven per cent during the same period, given the same underlying market assumptions. This reflects the relative differences in current P/E valuations.

“The valuations being as low as they are now (in emerging markets) will not last forever.”

Karyn West is managing director of the Australian operations for French fixed income specialists CDC Ixis, which owns a stable of 14 fund managers, including Loomis Sayles and Harris Associates.

West points to the strong recent performance by corporate credit investments, reporting a 14.8 per cent annualised gain since March 2002 for a flagship corporate bond fund, and says the party is not yet over in that investment segment.

“Credit has had a really good run over the last year or so, and we think it is likely to continue for the next 12 months,” she says.

She sees the non-government fixed interest market as continuing to improve, with better operating conditions leading to fewer corporate credit defaults — delivering better investment performance.

This is in marked contrast to the government bond market’s low return levels, which are driven by the Federal interest rate.

While Barry and West are clearly talking their books to an extent, the bottom line is that there is strong value in overseas markets — both stock and fixed interest — but that market selection is critical.

If the view of a mild upswing for the global economy taking global stocks along with it is correct, then together with the greater domestic currency strength, now is a good time to get into offshore investments.

Leveraging into these markets could be a useful means of maximising the number of ‘low hanging fruit’ investors can enjoy — possibly as a means of switching out of Australia’s overheated property market, while maintaining some tax deductibility and the level of total returns.

Advisers and their investors should also heed a lesson of the past: despite the models of value-driven investment managers, previous bull runs have typically shown that capital appreciation occurs fastest in the growth and blue chip stocks of major money markets — particularly the US and UK — regardless of relatively high P/Es.

The question is whether these can become the pick of the crop in the near-to-medium term — or whether the small cap/emerging market/ corporate credit value stories are the first to ripen.