Despite the recent strengthening of U.S. stock markets, the best prospects for making gains in equities lie in the eurozone, Japan and emerging markets, says prominent deep-value investor Charles Brandes, founder and chairman of San Diego, Calif.-based Brandes Investment Partners LP (BIP).
Brandes says that investors should take advantage of buying opportunities when the market cycle is down – that is, when stock prices are below their long-term intrinsic value. He says that now is an opportune time to move into equities, which he believes are “fundamentally attractive.” (BIP operates as Bridgehouse Asset Managers in Canada.)
Although BIP maintains that the eurozone still faces economic, political and regulatory risks, there are solid investment opportunities in the region. Louis Lau, director of investments with BIP, likes companies such as France-based multinational electric utility GDF Suez SA and Italy-based Telecom Italia, the largest telecommunications company in that country. GDF Suez stock is trading at 60% of its book value and pays a 9% dividend yield; whereas Telecom Italia is generating strong cash flows in the absence of cable competition in Italy and is improving its position in mobile and fixed broadband telecommunications.
Regarding Japan, Lau notes, the market’s opinion about investment prospects there is very negative. He says investors have criticized Japan because of its slow pace of change, too much government debt, poor corporate governance and shareholders’ rights, and its aging population.
However, BIP sees the Japanese market as “extremely cheap,” says Lau: “Japanese stocks are as cheap as they have ever been – except in the 1960s, when Japan started to grow.” (See story on page 27.)
BIP portfolios have significant exposure to Japan, with investments in sectors such as pharmaceuticals, telecommunications, technology, autos, insurance and banks. One of the holdings is MTT Corp., which is a telecommunications company engaged in producing state-of-the-art digital-signal processing technologies.
Since 2012, says Brandes, Japan’s market has been “up by 70% in terms of the yen and by 33% in terms of the Canadian dollar.”
Meanwhile, says Lau, emerging markets have been characterized by “fear, misconception and misunderstanding about what is really happening in these markets.”
They have suffered their worst period of underperformance vs developed markets since the 1997 Asian financial crisis. But the vast majority of emerging-markets nations have a very low external debt/gross domestic product ratio of 30% or less compared with their much more indebted developed counterparts.
Emerging economies are “far from crisis,” notes Lau, “despite what their markets and currencies might tell you” – referring to the fallout in emerging markets and the repatriation of funds to safer havens following the announcement of changes to U.S. monetary policy by the U.S. Federal Reserve Board in May in the wake of the strengthening U.S. economy.
Lau says emerging-markets stocks are trading at an average of 11 times earnings, compared with the historical average of 13 times. On the other hand, the S&P 500 composite index is trading at 17 times earnings and the MSCI world index at 16 times earnings, making emerging-markets stocks relatively cheap.
The outflow of funds from emerging markets “doesn’t affect the intrinsic value of companies” in these markets, argues Lau. He says BIP sees attractive value opportunities in Brazil, India, China, South Korea and Mexico.
In China, for example, BIP holds shares in domestic-focused companies such as Bosideng International Holdings, China’s largest winter down jacket manufacturer, which has a 35% market share. Bosideng is expected to benefit from growth in consumer demand for down jackets. This stock has an 11% dividend yield and is trading at about nine times earnings.
BIP does not spend a lot of time thinking about macro risks that can affect its investment strategies, says Lau, although the firm does conduct scenario analyses on potential risks. In Europe, BIP is paying attention to progress on austerity measures, debt, initiatives to stimulate growth and high youth unemployment. In emerging markets, the biggest risk is the possibility of contagion – as happened during the 1997 Asian crises – although, Lau says, “We are nowhere close to that.”
Regarding the U.S., Lau is “uncomfortable with utilities and industrials, and bond-proxy stocks like real estate investment trusts.” However, he sees value in both commercial banks that have record-high capitalization ratios combined with price/book valuations that are well below average and company-specific issues in the “boring” technology sector, such as Western Digital Corp., one of the largest computer hard-disk drive manufacturers, and Microsoft Corp.
In the case of Microsoft, for instance, Lau says, many investors view that firm unfavourably because they believe it has lost leadership in next-generation computing trends. However, in Brandes’ view, this is immaterial because Microsoft derives 80% of its profits from enterprise solutions, servers and the Windows operating system; has strong earnings and a strong balance sheet; and is trading at a discount to the average large-cap global technology company.
Brandes believes that “history is on the side of value investors.” He is finding businesses at attractive prices. And, although he anticipates bumps along the way in the short term, he expects that the markets will do well.
Says Brandes: “It’s necessary to underperform the benchmark [sometimes] to be an outstanding investor, [but] some people have difficulty tolerating underperformance.”
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