International Equity – 1Q21 Insights & Outlook

Transcript:

Where are some themes/opportunities you are excited about in the international portfolio?

Brian Barish: Generally speaking, international markets are a little less forward-looking and a little moodier than the US market. That’s just always been a common characteristic. We’re seeing this in 2021. In the US market, businesses that were deeply affected by the pandemic, such as companies in the travel and leisure space or other companies in let’s say restaurants and other forms of hospitality, they’ve recovered almost fully and in some cases have valuations that are above where they were pre-pandemic. That’s not true outside of the United States. You’re still seeing businesses that relate to travel and leisure, that relate to forms of infrastructure, where people tend to congregate, as well as the aerospace industry itself, they remain well behind, well below pre-pandemic levels.

We view this as an opportunity. We think that consumers and business people will travel in spades when they are fully enabled to do so, and that the pent-up demand is simply going to be very, very strong. And for those companies that are survivors that get through this with their balance sheets basically intact, the opportunity set will be excellent.

What are some key economic barometers you’re following closely as we move along in the year?

Munish Malhotra: We’re currently holding a barbell position across the portfolio. What that means is that on the one hand, we have a mix of secular structurally growing companies that are insensitive to the economy, and on the other side of the portfolio, we have cyclical businesses that are much more levered to any improvement in the global economy. So we’re not taking an active bet one way or another. We are watching to see how durable this economic recovery will be beyond what’s going to be a clear recovery off of depressed levels. And year-ago comparisons, we’re watching core inflation, core being ex food and energy, to see if this is spilling into wages, which are stickier sources of inflation.

We’re also watching consumer confidence and consumer spending to see if consumers are opening up their checkbooks and spending the money they’ve saved during the pandemic. In addition to that, we’re watching high-frequency data. This is data coming out of various companies that we follow. That includes hotel occupancy rates, air travel statistics, to see if air travel is indeed coming back. The willingness for people to travel and to get on planes, that’s a crucial sign of consumer confidence, and so we’re watching that pretty closely. Lastly, we’re clearly watching vaccination rollouts and COVID case counts globally, and we’re looking for any downward inflections in case count.

What are some countries/regions that you are particularly constructive on?

Munish Malhotra: We’re not necessarily betting on any one country or region. We are overweight and overexposed to the Asian consumer. Given favorable demographics across most of those countries, we are underweight in general in most of the developed world outside of the United States and that’s just purely simply due to more aging demographics, poor demographics. It’s important to understand that we are not necessarily enthusiastic about emerging markets. There are two different buckets of emerging markets.

One are commodity-producing countries. Those are countries such as Brazil, Russia, Mexico, South Africa, and the Middle East. These countries tend to be more volatile. Consumption tends to be more volatile. Economic growth also tends to be more volatile because they’re more commodity-dependent. The other side of the coin in emerging markets are more consumer-oriented countries, countries like China, India, various countries in Southeast Asia, such as Indonesia. We’re more optimistic about the Asian consumer in general, and we continue to be overexposed there.

On the other hand, we do think there is opportunity right now in Europe as well. We are overweight Europe and we continue to be overweight Europe. Europe, as you may or may not know, has been slower in terms of reopening their economy. That’s largely because the vaccine rollout has been a little bumpier to say the very least. But we think eventually the population will get vaccinated similar to what we’ve seen in the United States in Japan and therefore the quote-unquote recovery trade we think is still in the early innings there and so we tend to be overweight Europe at the moment.

Give the significant outperformance by U.S. equities, are there areas where international equities look more attractive for future returns?

Munish Malhotra: International companies in general, tend to be more economically sensitive, which is a plus at the early outset of any economic recovery. As corporate confidence and consumer confidence starts to improve, we should see international companies outperform their US counterparts. Given the lack of growth outside of the United States over the last decade in most parts of the world, many international companies have been forced to cut costs and restructure their businesses to be more efficient. So as a result, as we start to see an acceleration in global GDP companies outside of the United States, we should naturally see better earnings power.

In your 1Q21 Market Outlook podcast you discuss the potential for a ‘new interest rate regime”.  How are you positioning the portfolio for such an event?

Brian Barish: It’s possible given the aggressive central bank actions during the pandemic and as we are entering the first phases of the recovery, that we are entering some kind of new era of inflation and interest rates where they both go durably higher than they’ve been over the last 12 years since the financial crisis. It’s unclear whether they’re really going to be successful at that or not. It’s possible this is just one great big one-off event, but alternatively, central banks have been much more aggressive than they were following the financial crisis, and yet the plumbing of the financial system has remained pretty much in good working order through this whole process. We’re not quite sure what to think. At the moment we’ve elected to straddle this issue, which means we do own businesses that clearly need some form of higher interest rates and inflation for the stocks to work into 2022 and beyond, but we don’t want to over commit to that point of view.

One thought that’s a bit different in the international markets than you have in the domestic markets, in the US we have not used negative interest rate policy, or really, truly extreme forms of quantitative easing like they have in Europe and in Japan. The Fed has concluded that negative interest rates would be wildly unpopular; it would lead to less money supply growth in creation because it’s contractionary for the banking system and it would also lead to distortions in asset prices. For varying reasons they haven’t come to that same conclusion in Europe and Japan, and they have used negative rates or very extreme amounts of quantitative easing with very little to show for it. You have not seen inflation ever pick up two levels where the banks were targeting. You have not seen the currency depreciate beyond certain levels, even though you have essentially no return on cash balances.

So it’s possible. We don’t know this for sure, but it’s possible that if we get a burst of inflation, even if it’s transitory coming out of the 2021 to 2022 reopening outside the US, this will give those central banks some air cover to say, “Look guys, we did it. We finally got inflation to get out of this zero to negative rate level, and we can bring interest rates back up to a positive level.” That’s very interesting if you’re looking at financial companies outside the United States because their returns on equity, their margins, their risk profile have all been very badly distorted and generally in a poor way, as a result of negative interest rate policies. So a lot of optionality around just getting out of the negative interest rates, that’s how we see.

What are some near-term and eventually unavoidable risks facing international equities?

Brian Barish: The near-term risk for international markets we think are similar to those of the US, which would be some form of policy error by either monetary authorities or by governments. You’re already seeing a small amount of policy error in how various international governments have handled vaccination and the deployment of vaccines. Rather than being willing to pay up for excess coverage if you will, from various vaccine manufacturers, they went with the cheapest is the best approach, and that meant putting all their eggs in the basket of the AstraZeneca vaccine, which was thought to be the cheapest vaccine. What we’ve discovered is it’s not as good as some of the other vaccines, and in some of the clinical data that they’ve come through with has been a little bit difficult to interpret. So that’s led to delays and that in turn means less economic activity.

I think coming out of this, it is going to be very interesting to see how central banks act, how they react in fact to what may be some very elevated inflationary readings, or not. The other X factor is cohesion in places like the eurozone. Not all countries have the same borrowing capacity to borrow against their futures in order to fight off the current crisis, and you’re going to need to see some benevolence on the part of European aggregate authorities towards weaker countries. I’m thinking of Italy in particular. They don’t have much borrowing capacity left. They’re going to need some help from their neighbors. I think that will happen. I’m not too worried about it, but that’s something to think about.

Going over to Asia, your outlook for Asian economic growth increasingly is your outlook for Chinese economic growth. It’s so huge, it dominates everything. China is a very interesting and vexing challenge. On the one hand, they are continuing to move up the value-added ladder from the point of view of their industrial development, but things get harder here. China is run by an unelected government that has some totalitarian features to it for sure, and clings to at least notionally an ideology that is very much an anti-capitalist ideology.

The reality is somewhat different on the ground. Because they are an unelected government, their principle claim to legitimacy is bringing a better economy, bringing better living standards to their population in the aggregate. So if they fail to do that, they run all kinds of risks. So what do they do from here? They are regulating certain parts of the economy more aggressively in order to avoid things blowing up, for lack of a better way of describing it. This has happened with some of their internet giants that were starting to get into micro-lending practices without a lot of regulation. That actually does seem like prudent policy from my perspective, in terms of the Chinese government actions, but on the other hand, they’ve also shown some very central planning type of instincts, which don’t generally work particularly well in terms of advancing people economically. So tougher to say where China is going long-term. I think in the near term, I’m maybe a bit more optimistic than other people might be.