Global equities: Cheap stocks are becoming harder to find, managers say

Matt Moody, vice-president, investment management and a member of the Mackenzie Ivy team at Mackenzie Investments. The team’s wide range of mandates includes Mackenzie Ivy Foreign Equity and Mackenzie Ivy European Class. The Mackenzie Ivy team seeks to buy high-quality businesses and not overpay for them.

Peter Moeschter, executive vice-president and portfolio manager at Templeton Global Equity Group, Franklin Templeton Investments. A value manager, Moeschter runs both EAFE (Europe, Australasia and Far East) and global portfolios for retail and institutional clients.

Michael Hatcher, head of global equities and director of research at Trimark Investments, a division of Toronto-based Invesco Canada Ltd. A value manager, Hatcher’s extensive responsibilities include Trimark Europlus and Trimark Global Fundamental Equity.

Q: The International Monetary Fund estimates U.S. economic growth at 2.6% for 2015 and 2.8% for 2016. The estimate for the euro area is 1.5% for 2015 and 1.6% for 2016. Are you finding stock opportunities in Europe and the United States?

Hatcher: We’re finding Europe to be expensive, though it’s a great place to invest for the long term. In Trimark Europlus, we had 20.4% in cash and short-term investments at the end of October. Cash holdings in Trimark Global Fundamental Equity were minimal.

Moody: We’re finding the global equity market to be expensive in the context of slow global growth. At the end of October, Mackenzie Ivy Foreign Equity had 26.5% in cash and cash equivalents and Mackenzie Ivy European Class had 31.4%. While not all the growth of European-based companies comes from Europe, Europe is a decent-sized contributor to their growth and the economy has been weak.

Moeschter: We’ve been overweight Europe in our global portfolios for some time, but it’s stock-specific. It’s not as if we’re finding that everything in Europe is cheap. Valuations on quite a few European stocks have picked up, but not to the point that we have to be out of those stocks.

Q: The United States?

Moody: There are some positive economic signs coming out of the United States. It’s a relatively bright area in the global economy. From a stock perspective, we’re finding the same thing that we’re finding globally. It’s challenging for us to find opportunities in the United States, though we have found some isolated ones. Mackenzie Ivy Foreign Equity had 42% in the United States at the end of October and 22% in Europe.

Moeschter: We’re roughly below 40% in the United States in the global portfolios and have a weighting of slightly above 40% in Europe. We’re fully invested in the portfolios and don’t hold much cash. We’ve been finding select opportunities in the United States. The target might be a restructuring story or a situation where the market is undervaluing a company’s growth potential. Some of the domestic U.S. companies are doing quite well. The more global companies are probably feeling an impact from the strong U.S. dollar and the slightly slower global growth rate.

Hatcher: We’re finding the U.S. equity market to be fully valued, though it’s a little less expensive than Europe. We’re finding individual opportunities in the United States, more so than anywhere else.

Q: Trimark Global Fundamental Equity had around 22% in European stocks and 45.4% in U.S. stocks, at the end of October.

Hatcher: The companies that we’re looking to buy in the United States are not screaming buys. But many of them saw their valuations peak at the beginning of 2014. In particular, we’re finding opportunities in those U.S. companies that have partial exposure to the energy sector. It may impact 10% to 15% of their business, but it’s taking the growth shine off these companies. A recent addition was Flowserve Corp. (FLS), which makes pumps, valves and seals. It has a lot of repeat business. Flowserve is in the industrial sector, which is our biggest sector weight in the fund at 23.7%. This includes both developed and emerging-market stocks.

Moeschter: We’re underweight industrials. We also have indirect exposure to the energy sector through industrial stocks, but we’ve been increasing our investments in the energy sector directly through energy-services companies and some exploration and production companies and integrated energy companies. Energy is now an overweight sector in the global portfolios. A fairly recent addition is the global energy-services company Halliburton Co. (HAL).

Moody: Mackenzie Ivy Foreign Equity has zero direct weighting in energy. We’ve been adding to existing holdings of industrial companies with some exposure to the energy sector, or buying them for the first time. We initiated a position in W.W. Grainger Inc. (GWW) fairly recently. It’s a distributor of industrial products. It’s a well-run business. It has a strong return on capital and a strong corporate culture. Grainger is suffering, in part, because of the weaker oil and gas sector. The industrial sector was 12.7% of Mackenzie Ivy Foreign Equity at the end of October.

Q: Energy (representing 6.7% of the MSCI World Index) had a negative total return of 21.4% in the 12 months to the end of October in U.S.-dollar terms. Materials (4.6% of the index) had a negative total return of 10.4%. By contrast, industrials (10.7%) had a minuscule positive total return of 1%.

Hatcher: Given the weakness in the commodity prices so far this year, I would expect natural-resource stocks to be weak performers.

Q: The MSCI World Index in U.S. dollar terms had a positive total return of 2.3% for the 12 months to the end of October, which was pretty minimal. In calendar 2014, the index’s total return was 5.5% and 27.4% in 2013. What is the outlook for returns from global investing in 2016?

Hatcher: In this lower-growth global economic environment, valuations are high and I expect a 7% to 9% total return per annum for the equity market. This would be a normal equity-market return in a low interest-rate environment. This year’s return is likely to be less than that. The MSCI World Index’s return that you quoted for the 12 months to the end of October at 2.3% is in U.S. dollars, which is the most punitive currency yardstick. The U.S. dollar has been strong relative to most other currencies. Even if you go to the local currency of the constituent 23 developed-market countries in the index, it would probably bump up the return by, say, 150 basis points to, say, 3% or 4%. It’s still not a stellar year. For Canadians, the total return in Canadian dollars is considerably higher, given the weakness in the Canadian dollar versus the U.S. dollar.

Q: The MSCI World Index’s total return in Canadian dollars is 18.8% for the 12 months to the end of October versus 2.3% in U.S.-dollar terms.

Hatcher: The return in Canadian dollars from global investing over the next year or so depends a lot on where the Canadian dollar trades. If it strengthens, this will crimp returns in Canadian dollar terms.

Moody: On the outlook for the global equity market, we have simply been saying that stocks are expensive and it in no way means that they can’t get more expensive.

Moeschter: We’re still finding stocks that we consider to be cheap and that have upside. Is it as easy as it was three years ago? No. The markets are not as cheap as they were.

Q: Let’s examine the performance of some other sectors in the MSCI World Index in U.S.- dollar terms for the 12 months to the end of October. There are four sectors that did quite well. Consumer-discretionary stocks at 13.4% of the index had a total return of 15%. Consumer staples (10.3% of the index) had a total return of 9.4%. Health care (13%) had a total return of 6.8% and technology (14%) had a total return of 10.2%. Financials, the biggest sector weight in the benchmark at 20.6%, produced a negative total return of 1% over the period.

Hatcher: From a long-term perspective, we feel that consumer staples and information-technology companies are capable of producing high returns on capital and that the stocks should outperform. We’re typically overweight those two sectors.

Moeschter: Financial stocks, which are a big weighting in our global portfolios, move on interest-rate expectations. The stocks tend to pick up with expectations of higher rates.

Moody: Our biggest absolute sector weight in Mackenzie Ivy Foreign Equity is consumer staples. It has been for quite a while. The weighting is less than it has been traditionally. We’ve been finding this sector to be challenging. A lot of consumer-staples companies that we like are expensive. The stocks have done well and we’ve been reducing our holdings.

Editor’s note: This is part two of a three-part global equity round table.