Finding Value in International Equity Markets

David Herro discusses active management, his international equity market outlook, and finding value in today’s volatile landscape.

David Herro, CIO of International Equities for Harris Associates, says recent market turbulence and stock price declines likely do not reflect the business fundamentals of many quality companies and could represent value opportunities for active managers. Herro believes that while understanding political and economic instability is important, it should only inform – not supersede – an investment strategy’s longer-term convictions.

Areas of High Pressure
Ongoing tensions between the European Union and Britain over Brexit, combined with concerns related to Italy’s budget and Angela Merkel’s decision to step down as German chancellor in 2021, have affected European markets, particularly the banking and financial services sector. “I believe European financials have underperformed due to political noise,” says Herro. “Brexit fears remain in the market, given that the March 2019 agreement deadline is soon coming to bear. Combined with noise out of Italy and Germany, this has likely had a heavy negative influence on European financials.”

Divergent Currencies
According to Herro, the strength of the US dollar – which has been supported by evidence of continued growth in the US economy – has also influenced European financial companies. “The dollar has been extremely strong,” he says, “especially against the euro – and most European companies are denominated in euro. A falling currency has probably compounded the effect of political tensions.” If the dollar continues to strengthen, international equities may continue to feel its effects in the near term. “The British pound sterling and the Japanese yen have weakened quite substantially since their highs in February 2018,” says Herro, “which is likely also weighing on the US dollar returns of foreign stocks.”

Trade Talk, Tariffs and Traffic Reports
Agreement on the USMCA trade deal has helped to quell trade dispute anxieties in North America, while rhetoric between the US and European leaders on trade issues seems to have softened. Nonetheless, the ongoing trade war between the US and China has likely begun to affect markets – not least because the situation has moved well beyond the rhetorical. “The trade policy threats going back and forth between Europe and the US seem to have dissipated. The biggest impact on trade has been the dispute between the US and China,” Herro explains. “Instead of just talk, we’ve seen actual tariffs placed on bilateral trade movements. The Chinese auto market has slowed as a result of this trade friction, as have the short-term earnings of many European automobile producers.” With an eye on longer-term developments, Herro maintains that only a relatively small percentage of European automakers’ total output is likely to be affected by Chinese tariffs. In addition, “vehicles being imported into China from Germany and other European markets have actually seen tariffs decline.” What’s more, European automakers may also see increased efficiency as they adjust to new emissions testing standards.

Faith in Fundamentals
While he recognizes the market effect of recent political and economic commotion worldwide, Herro suggests international equity investors guard against any urge they may have to default to emotional investment decision making. In fact, he believes that adhering to the core convictions of an active management approach may be even more important during market downturns and may even lead to value opportunities. “While we might see decidedly negative price movements in European companies, what we have not seen is a corresponding decline in fundamental business value,” says Herro, adding, “We don’t see it in the earnings.” While short-term market dynamics can weigh on relative performance, he believes the intrinsic value of a portfolio is better determined through an informed and thoughtful analysis of these fundamentals and how they might develop over the long term.

“I believe many of the earnings changes we’ve seen aren’t anywhere close to what’s happening with price – that is what opportunity is about,” says Herro. “The short term might not be a pretty story,” he proposes, “but being invested in quality companies at a very low price is a question of business fundamentals, not political noise, and this is the essence of value investing.”
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