Are International Equities Out of the Woods Yet?

by: Billy Fisher

International equities have been among the hardest hit during the market’s recent downturn.

I don’t know that I will be jumping on board anytime soon, but Citigroup (NYSE:C) notes that at 10.3 times trailing earnings, world-wide stock valuations have tanked to levels worse than that of an 11.4 average for the 1970s.

To an extent, forward P/E ratios have lost some of their predictive value. After we have seen a slew of downward revisions by companies reporting their third-quarter earnings, these ratios have become moving targets.

A Downward Spiral

Country-focused ETFs have experienced quite the slide in 2008. The iShares MSCI United Kingdom Index Fund (NYSEARCA:EWU) has fallen 43.3%. The iShares MSCI Japan Index Fund (NYSEARCA:EWJ) and the iShares FTSE/Xinhua China 25 Index Fund (NYSEARCA:FXI) are down 32.0% and 55.1%, respectively. Conditions have been abysmal in Russia where the Market Vectors Russia ETF (NYSEARCA:RSX) has been hammered for a 62.9% loss so far this year. For comparative purposes, the SPDR S&P 500 ETF (NYSEARCA:SPY), an ETF that tracks the S&P 500, is down 32.6% year-to-date.

Money managers that I have spoken to have generally conceded that international stocks are cheap, but continued volatility and additional downside risk remain among their top concerns for investors looking to buy in to foreign equities.

Bets in the Pacific

David Hogan, client portfolio manager of the Laudus Mondrian Emerging Markets Fund (LEMIX), noted that his fund is underweight U.S. equities while it favors names in Australia, Japan and Singapore. The fund also likes companies in Turkey and Taiwan. Taiwan Semiconductor Manufacturing (NYSE:TSM) was a top five holding of the fund as of June 30th.

On Thursday, the chip maker reported third-quarter results that included a 4.5% rise in total revenue on a year-over-year basis. Net income remained relatively flat versus the company’s year ago quarter.

Right now Taiwan Semiconductor Manufacturing sits 30% off of its 52-week high achieved in June. The trail ahead is not expected to get any easier. The semiconductor sector has been among the worst performing sectors in 2008. Sales are expected to decline by between 5% and 9% in 2009 in the global semiconductor market.

The Nikkei Bounces Back

When I talked to Chad Deakins, portfolio manager of the RidgeWorth International Equity Fund (SCIIX), he seemed to think that Japanese stocks were among the most attractive valuations with U.S. stocks being a close second. As of September 30th, East Japan Railway (OTCPK:EJPRY) and Nintendo (OTCPK:NTDOY) were two Japan-based companies that were among his top holdings.

While earnings have been way down for many Japanese companies, East Japan Railway has been holding its ground. For the six months ended September 30th, the company saw a 2.1% decrease in operating income on a 1.4% rise in total revenue. 

Nintendo has also been able to produce robust operating results based in part upon the strength of its Wii platform. For the three months ended June 30th, the company reported a 33.7% spike in net income on a 24.4% increase in net sales versus its prior year quarter.

Looking at Japan on a macro basis, Deakins’ call is becoming increasingly attractive by the day. Japan’s Nikkei index is up a shocking 27.2% since its close on October 27th. On the ETF front, EWJ was among the leaders in volume on Tuesday as it rose by another 5.5%.

Despite these strong advances upwards, investors should keep in mind that Japan and many of the other world economies mentioned here are coming off of lows that haven’t been seen in decades. Many challenges also continue to lie ahead. While valuations are certainly compelling for some of these foreign plays, I think it might be a bit premature to assume that they can’t go any lower.

Disclosure: none