- The Fed’s Quantitative Easing policy has led to historically high values for US equities and bonds.
- QE is expected to taper off by this fall (October-November 2014), and interest rates are expected to rise in 2015.
- Foreign equities offer an uncorrelated investment, providing exposure to growth without accelerating risk.
With U.S. equities trading at historically elevated levels, I thought I'd investigate some investing opportunities that would offer an alternative to the expensive U.S. market but still provide growth opportunities. Although bonds, including U.S. Treasuries have a negative correlation to equities, their yields are so low that if interest rates move towards the historical average of 4.6%, you would be looking at taking substantial losses (we're 43% below the average yield).
Shiller P/E ratio
U.S. Treasury 10-Year Rate
I agree with the analysis that equities and bonds are more expensive than historical averages due to the U.S. Federal Reserve's massive stimulus program in effect since the fall of 2012, otherwise known as Quantitative Easing. At this point, there appears to be a higher supply of money than investment opportunities in the U.S. market, so prices have soared past historical averages.
However, the Fed is tapering QE by $10 billion a month and the program looks like it should be finished around October or November of 2014. Interest rates are expected to gradually increase to (hopefully) match inflation as the economy continues to improve (slowly). At this point we will be faced with a more normal supply of money and yields should increase. Historically, higher rates put pressure on the returns in equities and bonds. While I'm not saying the bull market would be over at this stage, I'm skeptical that we will see markets as complacent as they are today.
This leads us to a difficult choice for investing today. If equities are elevated beyond their historical average, then there is a higher-than-normal risk that equities will correct towards the mean over the next five years. I believe the same can be said for bonds. Where can you put your money to work? A savings account? With the highest rates around 0.95%, you're guaranteed to lose money to inflation. Money markets in today's market offer little to no benefit over savings accounts. Certificates of Deposits take away your liquidity for a rate that's maybe 0.5% higher than a savings account - and you're still getting beat by inflation! What about real estate? Whether you own a REIT or buy your own property, real estate typically is a highly-leveraged investment - the higher the leverage, the greater the sensitivity to interest rates. There's a risk to the returns on real estate in a rising interest rate environment. Most REITs on the market haven't been around when interest rates were more than triple what they are today.
I think it's prudent to look overseas where foreign central banks are beginning stimulus programs (Eurozone and Japan). Another area to look at would be foreign companies with exposure to fast-growing frontier markets (Africa, Latin America, and South East Asia) where growth is more dependent on commodities that act as a hedge in inflationary environments.
My article today will focus on 10 foreign equities - one from each sector of the economy: consumer staples, consumer discretionary, industrial, technology, health, financials, raw materials, energy, telecoms, and utilities. I am focusing on foreign companies with American Deposit Receipts (ADR) that have decent liquidity. My goal is to find growth at a reasonable price with a decent dividend yield - you can find my domestic equity picks here and here).
1. Consumer Staples: Unilever (NYSE:UL). From Dove soap bars, to Axe deodorant, to delicious Magnum ice cream bars, it's hard to find a house devoid of Unilever products. A company too good for merely one HQ (London AND Rotterdam), Unilever has a trailing P/E ratio of 19.91, a forward dividend yield of 3.5%, a return on assets of 10.01%, and a return on equity of 34.22%. Unilever's American rival, Procter & Gamble has a P/E ratio of 21.23, a forward dividend yield of 3.2%, return on assets of 7.34%, and the return on equity is 16.01%. Both are excellent companies with excellent products, but Unilever offers a slightly better value, yield, and returns. Unilever offer's two American Depository Receipts, (NYSE:UN) based out of Rotterdam, and based out of London. I chose the UL version since the British-based company will not withhold taxes. If you are willing to claim the foreign tax in a taxable account, then the UN shares are a slightly better value.
UL Year to Date Total Returns data by YCharts
2. Consumer Discretionary: Toyota Motors (NYSE:TM). The world's largest car manufacturer, Japan's Toyota Motor Corp offers a low P/E ratio of 10.18, a forward yield of 2.1% a return on assets of 3.73% and a return on equity of 14.23%. I'll compare it to Ford, which has a low P/E ratio of 10.30, a forward yield of 2.9%, a return on assets of 1.48% and a return on equity of 28.94%. Ford leverages its debt for better returns, but it's more volatile during transitions in economic cycles as result. Due to its volatility, the automobile sector already has a low P/E ratio, so there isn't much to gain in value by going overseas. However, Toyota offers exposure at a good value to the Japanese economy which is in the middle of its own stimulus program. If you'd rather gain exposure to the Indian economy, take a look at Tata Motors (NYSE:TTM) with a P/E ratio of 8.47, a forward yield of 0.3% return on assets of 7.62%, and return on equity of 27.01%. With a pro-business government in power, Indian stocks have already started to rise this year.
TM Year to Date Total Returns data by YCharts
3. Industrial: ABB Ltd (NYSE:ABB). In the Industrial sector, I would recommend the Swiss Industrial giant ABB. ABB produces robotic, power, and automation technologies. As the world's largest builder of electricity grids, ABB has diversified revenue streams to benefit from worldwide GDP growth. Whether it's producing wind turbines, or electric inverters and control systems for solar power, ABB also has a strong presence in the fast growing renewable energy sector. Although the company's revenues have slowed down recently, I believe ABB offers a compelling long-term investment in a foreign industrial conglomerate. Shares are down 12% for the year, offering a reasonable P/E ratio of 20.02, a forward dividend yield of 3.3%, a return on assets of 5.49%, and a return on equity of 15.01%. I'll compare the valuation to Eaton Corporation (NYSE:ETN) since many of their products directly compete; has a P/E of 19.25, a forward dividend yield of 2.6%, a return on assets of 4.25% and a return on equity of 11.97%. ABB is slightly more expensive, but offers a better dividend and more direct exposure to Europe's recovering economy.
ABB Year to Date Total Returns data by YCharts
ABB PE Ratio (TTM) data by YCharts
4. Technology: Taiwan Semiconductor Manufacturing Company (NYSE:TSM). The world's largest dedicated semi-conductor foundry, TSM offers a direct way to invest in the sprawling semi-conductor industry. TSM's customers include industry giants such as Qualcomm (NASDAQ:QCOM), Nvidia (NASDAQ:NVDA), Advanced Micro Devices (NYSE:AMD), Broadcom (NASDAQ:BRCM), and Xilinx (NASDAQ:XLNX). TSM's P/E ratio is 17.06, has a forward dividend yield of 1.9%, a return on assets of 11.55% and a return on equity of 23.06%. TSM's main domestic competitor would be Intel, which offers a P/E ratio of 16.16, a forward dividend yield of 3%, a return on assets of 9.04% and a return on equity of 17.40%. While TSM might be slightly more expensive than Intel, it manages to generate more profit with its assets. TSM's Price to Earnings Growth Ratio or PEG ratio is also less than half of Intel's (0.98 vs 2.2), meaning that there's a larger safety margin in meeting next year's earnings expectations. If software service is more to your liking, you could look at Indian consulting companies like Infosys (NYSE:INFY), or Wipro (NYSE:WIT), or Germany's software service giant SAP (NYSE:SAP). All three are down YTD after strong runs in 2013, but I think they will continue to grow in the long run. With lowest P/E ratio of 17.82, INFY is in the process of a turnaround after bleeding customers to its rivals, but I think its value today makes for an interesting starting point.
TSM Year to Date Total Returns data by YCharts
5. Health: Novartis (NYSE:NVS). As of April, 2014 Swiss-based Novartis became the largest pharmaceutical company (excluding medical devices), thanks to increased sales in diabetes (Galvus +60% sales) and cancer drugs (Afinitor +60% sales), while the former leader, Pfizer, struggled with the patent loss of its cholesterol drug (Liptor -40% sales). Novartis has a trailing P/E of 23.21, a forward dividend yield of 3.0%, a return on assets of 5.83% and a return on equity of 14.31%. Pfizer, offers a lower P/E of 18.16 (Yahoo Finance shows 9.24 while Google finance shows 18.16 - I'm assuming the discrepancy is due to one-time charges), a forward dividend yield of 3.5%, a return on assets of 5.75% and a return on equity of 13.75%. Novartis is more expensive than Pfizer, but Novartis's revenue is still growing, while Pfizer's is shrinking. Novartis's PEG ratio is 3.22 whereas Pfizer's is at 4.39. If I had to choose between growth at a slightly higher price vs shrinking profits at a lower price, I'd chose the former. With other pharma powerhouses like AstraZeneca (NYSE:AZN) and GlaxoSmithKline (NYSE:GSK), the Eurozone's pharmaceutical industry is a bright spot in an otherwise lethargic economic environment.
NVS Year to Date Total Returns data by YCharts
6. Financials: Santander (NYSE:SAN). The Eurozone's largest bank by market value, Santander offers exposure not only to Europe, but also fast-growing Latin American economies. Like the financial sector in general, Santander has struggled to return to pre-2008 financial crisis levels (still down 50% from April 2008). Santander has also been negatively affected by the Eurozone's sluggish recovery since the crisis. However, with the European Central Bank enacting negative interest rates in June 2014, I think European financial institutions will see faster earnings growth than the previous 5 years. In fact, Santander's stock has already risen 61% from June 2013! As a result, Santander's P/E ratio at 19.57 has already zipped past American banks' ratios. However, Santander does offer a massive forward dividend yield of 6.20%. Return on equity is 6.65%. JP Morgan has a P/E ratio of 14.26, a forward dividend yield of 2.8%, and a return on equity of 7.81%. Santander offers exposure to Europe's stimulus program and faster emerging market growth in Latin America. While prices have soared over the past year, the stock is a long way off from its pre-crisis levels, it offers a substantial dividend to patient investors.
SAN Dividend Yield (TTM) data by YCharts
SAN Year to Date Total Returns data by YCharts
7. Basic Materials: BHP Billiton (NYSE:BHP). The world's largest mining company, Australia's BHP Billiton provides investors diversified exposure to base metals, coal, oil, and gas. As a result, BHP's fortunes serve as a bellwether of global economic growth. When developed economies stumbled during the financial crisis, BHP Billiton's stock dropped 50%, but rapidly regained most losses within a year due to demand from China's manufacturing sector. However, as China's economy slows down, BHP's stock has flat lined since 2011. However, as demand from China drops, I think the gradual recovery of developed markets will help pick up the slack in demand. Also, there are other emerging markets picking up growth (Africa, Latin America, and South East Asia) that should provide further earnings growth for BHP. BHP's P/E ratio is 12.17, a forward dividend yield of 3.5%, a return on assets of 8.95% and a return on equity of 21.45%. BHP's American competitor would be Freeport-McMoRan (NYSE:FCX), which has a P/E of 14.27, a forward dividend yield of 3.6%, a return on assets of 6.14%, and a return on equity of 13.49%. When inflation picks up - you want exposure to a commodities producer, and you will be hard-pressed to find a better-run company in this sector than BHP Billiton. While China's economic slowdown will dampen returns in this sector, in the long run there are lots of emerging economies that will only add to demand for raw materials.
BHP PE Ratio (TTM) data by YCharts
BHP Year to Date Total Returns data by YCharts
8. Energy: Total (NYSE:TOT). Energy companies also provide gains in a rising inflationary environment as well as protection from geopolitical disruptions in energy supply. Looking at foreign-owned energy companies, I chose France's Total mainly due to their investments in solar energy and diverse exposure to worldwide economies. While China's CNOOC (NYSE:CEO) offers a better value, I feel their profits will feel pressure from China's lowered growth projections. Shell is more expensive and has announced the sale of $15B in assets which I feel will limit future growth. Total also owns 60% of Sun Power, which I see as a prudent move to diversify their energy mix. Total S.A. has a P/E of 12.79, a forward dividend yield of 4.7%, a return on assets of 6.62%, and a return on equities of 13.14%. Exxon, has a P/E of 14.14, a forward dividend yield of 2.7%, a return on assets of 8.2%, and a return on equity of 11.02%. While the oil business is generally a global business anyways, Total offers a mix of good value, a large (albeit erratic) dividend, and diverse energy revenue.
TOT Year to Date Total Returns data by YCharts
9. Telecom: Vodacom (NASDAQ:VOD). The world's second largest telecom with over 400 million subscribers across three continents, Britain's Vodafone is my top choice for an International Telecom. I like Vodacom's exposure to sub-Saharan African economies which I think offer strong returns over the next 10 to 20 years. Vodacom is also the second largest telecom in India, which I think still offers growth potential, especially with a more business-friendly government in power. Vodacom's P/E ratio is 4.55, a forward dividend of 5.7%, a return on assets of 1.5%, and a return on equity of 15.68%. I'll compare Vodafone to AT&T, since Verizon recently split off from Vodafone. AT&T has a P/E of 10.32, a forward dividend yield of 5.2%, a return on assets of 6.92%, and a return on equity of 20.61%. Telecom's slow growth and high dividend yield allow for some stability in a portfolio. Although they tend to be capital-intense or high-debt businesses, I think Vodafone will be in a good position to leverage its debt in a stimulus-friendly Eurozone, while taking advantage of its exposure to fast growth markets.
VOD Year to Date Total Returns data by YCharts
10. Utilities: Huaneng Power International (NYSE:HNP). With the largest customer base in the world (surpassing the United States in 2011), I had to pick a Chinese company for an international electric utility. Huaneng Power International is one of the five largest power utilities in China and they are the only one that I could find with an ADR with decent volume. Although China's economic growth is slowing down, its effect will be less profound on a less-cyclical and heavily-regulated sector like utilities. HNP has a P/E ratio of 9.11, a forward dividend yield of 2.9%, a return on assets of 6.64%, and a return on equity of 19.5%. I'll compare it to the largest power utility in the United States, Duke Energy (NYSE:DUK). DUK offers a P/E of 26.45, a forward yield of 4.4%, a return on assets of 3.21%, and a return on equity of 4.73%. HPN offers exposure to the massive Chinese electrical market at a bargain P/E ratio. HPN also appears to be well-managed by providing strong returns with its equity. However, dividend growth investors may be disappointed with erratic dividends.
HNP Year to Date Total Returns data by YCharts
I'm not suggesting abandoning U.S. equities with this list. I just want to show places for investors to put money to work that might be less-susceptible to a transition to a post-QE world. I tried to pick solid companies with a history of good returns and solid growth prospects - without paying a fortune for these features. Maybe there are faster growing companies in their respective sectors, or companies available at a better value, but I hope my list comes close to finding a balance between both needs.