Why foreign stocks are beckoning US investors

Investors in Wall Street's long-running bull market are obviously a very happy bunch. But many who now question just how long the party will hold up have started looking elsewhere to move at least part of their money. And these days, the international equity markets are beckoning -- enticingly so.

Indeed, recent trends have fueled rallies in Europe and the emerging markets, analysts point out, although the US equity market continues to have an enormous lead on the rest of the world after the financial crisis. Many global market analysts note that prices are no longer cheap by historical standards, but even so, international stocks look more favorable compared with US stocks.

"Earnings will continue to be an important driver of the aging global equity bull market, but we expect stronger growth in Europe and the emerging markets," said Justin Thomson, chief investment officer at T. Rowe Price and lead manager of its International Small-Cap Equity Strategy unit. "It looks like in dollar terms, 2017 will be the first year that we [international] outperform domestic or US equities since 2012," he pointed out.  

What's different now? "The dynamic has changed this year, with Europe being one of the major surprises," noted Thomson, pointing to how political risk has receded. And in the emerging markets, "we've seen a pickup in growth, particularly from laggards like Russia and Brazil," he said. And "Japan has had a very good year for earnings growth despite a relatively strong yen," he added.

But the biggest surprise was China, where inflation and nominal GDP have unexpectedly gone up, noted Thomson. What's not well understood, but what's happening, he said, "is structural reform where previously a lot of their old economy industry suffered from overcapacity." He noted that "through government intervention and through market forces, a lot of that capacity has been down." 

So growth and inflation have gone up, he said, while earnings are up, but bad debts are down, and "I think this this could continue, and the market will broaden and be a bigger part of all our investment horizons," said Thomson.

At the Thornburg International Value Fund, portfolio manager Lei Wang also expressed great optimism over the international equity market's advance and future prospects. He noted that international stocks continued to march higher in the third quarter of 2017, largely on the back of both strong corporate results and improving economic fundamentals. "In aggregate, companies posted another round of double-digit earnings growth," he added.

Wang said it's notable that "even with the robust year-to-date return, what private investors are paying for international stocks as measured by price-earnings per share is largely the same as at the start of the year, and remains well below the equivalent metric for US equity markets at the broad market level."

All sectors in the benchmark indexes of Wang and his co-portfolio manager, Di Zhou, produced positive returns in US dollars, with a few marginally negative in local currency terms, as the dollar continued to weaken.

At T. Rowe Price's international equity unit, Thomson pointed out that the structural composition of Europe in 2008, during the last peak, 57 percent of earnings came from a combination of financials, energy and commodities. Analysts at T. Rowe Price remain "relatively skeptical about the commodities complex."

"I think the big swing factor here will be financials," said Thomson, noting that a lot will depend on the direction of interest rates and the spreads that banks can earn in Europe.

The problem investors face in trying to invest in the international equity markets -- as in every other equity market -- is which stocks to buy. Among the many names in T. Rowe Price's vast portfolio holdings, here are three stocks Thomson recommends:

Yoox Net-A-Porter Group, headquartered in Italy, is an online retailer for the fashion and luxury industry. It's the clear leader in this industry, which Thomson expects will grow at double-digit compound annual growth rate for the next decade, given current low online penetration of 7 percent for branded luxury goods. Improved pricing power and operating leverage should also boost EBIT (earnings before interest and taxes) margins in the years ahead.

IQE is a leading UK manufacturer of advanced semiconductor materials and wafers. They're primarily sold to the wireless industry (70 percent of revenues) and are strongly tied to smartphone upgrade cycles. IQE also has the leading technology for wafers used for 3D sensing in consumer electronics, like smartphones, and in other industrial applications.

Abcam, also headquartered in the UK, is a fast-growing biotech company that has an effective internet sales channel to deliver antibodies to the scientific research market. It has built both a strong research base and a distribution system that have allowed it to create the largest online antibody resource in the world, while also ensuring that the antibodies are of high quality and commercially viable.

All three stocks were purchased and held in the T. Rowe Price International Discovery Fund (PRIDX) since Sept. 30, 2017.