International Stock Picks From Audrey Kaplan of Federated Investors

On October 10, 2007, Forbes Investors Advisory Institute hosted a Financial Round Table discussion among several leading investment authorities on the global and US economies and securities markets and their specific investment recommendations. From the Roundtable, hosted by Wally Forbes, here's an excerpt from Audrey Kaplan, Senior Vice President of Federated Investors where she manages the Federated InterContinental Fund [RIMAX].

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Basically, we believe that the US is in the midst of a mid-cycle slowdown. Growth is slowing in the US but, at Federated, we say it’s slow but steady. We’re not too concerned with the growth rate since there is steady growth. However, the situation in international markets is very different. Growth is not slowing. It is above trend in many of the markets that we follow. The InterContinental Fund looks at six continents, and more than forty countries for investment opportunities. The majority of those countries are expecting above-trend growth in calendar years ’07 and ’08. In fact, it’s the first time in two decades, I believe, where forecast US Real GDP growth is going to be the slowest of all the regions that we monitor. That’s going back for about twenty years.

What does that mean? Asia, excluding Japan, is one of the regions that we follow. We’re overweight in the Asia ex Japan region in the InterContinental portfolio and we’re expecting growth in ’07 and ’08 to be 8.5% and 8.1% respectively in Asia ex Japan. Even in the Euro zone, we’re expecting growth of Real GDP for the entire Euro zone, thirteen countries. Our forecast is 2.5% and 2.3% for ’07 and ’08. Compare those numbers to the US, where we’re expecting less than 2%. Our forecast for ’07 US growth in GDP is only 1.9% and ’08 slightly above at 2.0%. So, our estimates for all the other regions are for faster growth compared to the US economy -- even in Japan.

To bring that back to the US market, we’re expecting most of the large-cap stocks to get a good share of demand from overseas. So, we would be looking at larger US companies that are very globally oriented. For technology companies, typically more than half to three-quarters of their profits are coming from overseas. So, technology is an area that we prefer. One stock I looked at, Intel (INTC), gets 85% of its profits from overseas. Based on similar analysis of a wide range of companies, we favor large-cap stocks over smaller and globally-oriented stocks over domestically-oriented and we also favor technology stocks over consumer stocks. I want to talk more about the international stocks and our asset allocation.

We are recommending that moderate-risk clients have a minimum of 23% in international markets. The number one way to achieve a successful return in international markets is to have a country allocation process that helps you determine which countries will outperform. Our research shows that in a well-diversified international portfolio, 80% of the return variability comes from the country allocation. So, we’re doing the majority of our InterContinental research, aimed at getting the correct country decisions, the important big decisions correct.

Currently we’re overweight in the Euro zone, including German shares and Italian shares, and also other areas of Europe. But Germany and Italy are two of our favorite markets right now. Sam mentioned that the P/E of the US was 15.3x. The P/E of Germany is 12.9x. A lot of strong growing companies in Germany are trading at a very reasonable valuation compared to the other worldwide economies. In fact, one month ago more than 25% of German companies’ earnings revisions for two fiscal years (’07 and ’08) were getting upgrades in their earnings per share. In Italy the story is not so much growth driven. Rather, it’s that the valuations in the Italian stock market are the cheapest in the world right now -- trading at less than two times price-to-book value. There are a lot of banks in Italy and the regulatory environment is improving. They’re on course for a market rebound. We definitely like several companies in Italy. In Asia we’re overweight both South Korea and Taiwan. Both of these economies are strong. They’re greatly benefiting from the strong growth coming from emerging markets.

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Let’s talk about some of the stocks that we like. Primarily our stock decisions are driven by the countries that we favor. I already mentioned that our number one rated country out of thirty-five countries right now is Italian shares. It’s a smaller developed market. We like smaller developed markets because they’re less correlated to the US. If you’re investing in the UK, those shares move in line with US shares 80% of the time, whereas some of the smaller developed markets, like Italy, or Norway, or Austria, tend to have a lower correlation to US stocks. Italian shares that we own include a couple of banks that we like. Unicredito Italians SpA (Sedol 4232445) and Intesa Sanpaolo (Sedol 4076836) are two financial firms that we like. Those two do not trade ADRs.

A company that we own outside of the banking universe and that does have ADRs, is Benetton Group SpA (BNG), a well known brand, nationally and internationally recognized. Another stock we like is Fiat SpA, but that also does not have an ADR. I’ll just make a point about ADRs and our portfolio in general. We’re finding that 70% of the best growing companies, growing their earnings strongly, profitable companies, and trading at reasonable valuations are actually local shares. So it’s a little difficult to limit yourself to ADRs. If I switch from Italy to Germany, which is a close second place to our Italian country ranking, the German market also has attractive valuations. Growth is good, as are exports. Shares of sleepy old German companies that everybody’s been avoiding are now among the world’s largest exporters into Asia and into the US as well.

Some of the companies that we’re overweight in Germany do have ADRs, such as Deutsche Bank (DB), DaimlerChrysler (DAI), and Siemens (SI). Those are three good companies that represent the economic diversity of the German economy. In Asia, because of market restrictions, it’s very difficult for a US retail investor, or an individual to invest directly in the local market.

In South Korea, for instance, a lot of the best stories, or the best companies to invest in, are only available to institutions. But let me highlight a few companies that do have ADRs: Posco (PKX) and Kookmin Bank (KB) -- both in South Korea. In Taiwan we own Taiwan Semiconductor (TSM). And we have several other local shares in each of these markets. We typically prefer the local shares in both South Korea and Taiwan which trade at discount to the US ADRs.