Currency traders are seeing distortions that they haven’t seen in over 3 decades. With a continued strong labor market, rising interest rates and few other attractive alternatives, the US dollar is having a rally no one expected.
Against major currencies, the dollar is pressing ahead into new territory. The yen at 142.5 per dollar, is touching a rate last seen in 1990. The Euro is less than a dollar for the first time since around when it was unveiled and the pound hasn’t been this low against the dollar since the Plaza Accords of 1984.
There is chatter again about the wealthy in the US snapping up homes across Europe and the lower cost of imports will help to bring down inflation in the US.
Things could well get worse before they get better. There is talk of seeing the Euro at 90 cents to the dollar this winter thanks to the energy crisis and expected recession that Europe is facing. The Bank of Japan does not look as if it may yet intervene in the currency markets to prop up the yen and the UK is looking at political weakness and increased spending which could further deteriorate sterling.
The strong dollar will see US trade deficits widen and will likely add to inflation in foreign markets. It will hurt companies and countries with higher amounts of debts denominated in dollars. Despite this, there doesn’t seem to be any international pressure developing to press the US on weakening the dollar just yet.
So now may be as good of a time as ever to get your hands on some global assets. If you can’t afford a second home in Europe, don’t worry, you can at least snap up some great businesses there and in other places.
Why to Buy
Before I get into the spreadsheet I created to start to think about where to buy, it helps to reiterate why anyone should be buying foreign stocks right now.
Since the global financial crisis in 2007-2009, the US has been the place for stocks. The S&P 500 and the Nasdaq have roundly trounced global markets since that time. Some of this was due to higher profitability and the bounce back from the crisis and some of it was due to higher valuations. With that being said, other markets returns have ranged from paltry to pathetic.
Europe mustered barely half the growth in equity prices that the US did and emerging markets suffered what is becoming a lost decade and a half. A few markets such as India had bright spots but other stars such as China were clouded with political uncertainty.
Yet this situation cannot remain. Despite the S&P 500 being down 14.4% year to date, the PE of the index remains at 22 times. Not terrible for the US, but still elevated compared to global levels. At some point, growth will transmit to other places and the dollar will weaken. When that happens, many may have wished they were able to take advantage of the current situation. Over long periods of time, say 15 to 20 years, currency fluctuations tend to cancel themselves out. Europeans saw the Euro strong in the mid 2000’s and flocked to New York for shopping to take advantage. Brazilians did the same when the real was strong at that time. Over shorter periods of time however, like intervals of 5-7 years, currencies can remain strong or weak compared to others as market forces take time to adjust on a macro level.
What this means is that astute long term investors can take advantage of price swings that may last a few years. When the dollar eventually does weaken, prices for foreign assets will rise and will have a multiplicative effect on returns for US investors in those assets. It helps to keep in mind that for a US investor in foreign stocks, returns = market returns x currency returns.
With that in mind, I took a look at a number of different investable national markets, mostly through BlackRock’s iShares ETF products which are the widest ranging and most liquid of country ETF’s that I’m aware of. What I found were some great deals on various international markets that a committed long term investor can take advantage of now.
Where to Invest
Before I show my list, I whittled down the names by taking out those that didn’t meet a few criteria. I took out those that were under dictatorships or military governments such as Turkey or Thailand. Given the recent global political events like those in Ukraine, it should be obvious that authoritarian governments like this can add some nasty negative surprises for investors that I want to keep away from. In this same light, I took away large cap Chinese shares, they are now in many large indexes and I feel they have too much visibility and pose a perceived threat to the Chinese government which has been arbitrarily beating them into submission. I did include Chinese small caps for the reason that they could skate by with a lower profile on the radar of the government there.
I also stayed away from countries whose markets were too small and concentrated. Think Belgium or Austria. Not bad places, but their stock markets are very small and tend to be dominated by a few firms. The exception I included here is the Netherlands, where the chip provider ASML takes almost a quarter of the local stock market, but the past returns were too good to ignore.
Finally, I kept out of weak markets that were both small in terms of market cap or had offered dismal returns over the past 10 years. The Philippines and Malaysia fell into this bucket, so I left these out.
I ranked each market in terms of its PE, dividend yield and gave extra points if it was a small cap fund as these have been shown to give slightly higher returns over time across different markets. The result was an index score for 29 different funds. Which I have produced below.
The ETF’s are ranked from lowest score to highest, lowest being the best. I have highlighted my personal picks out of these in blue and below I will explain why.
Brazil
Brazil has been a bummer of an investment for over a decade. Despite this, the valuations are currently just too attractive to ignore. The massive dividend yield here is a bit of an anomaly at the moment. The ETF is a quasi commodity play as Petrobras, the state oil company and Vale an iron ore mining company, make up a little less than a third of the ETF. Yet Vale has seen big profits due to rises in iron ore prices and is paying out dividends via a transparent formula based on their operating profits.
Petrobras is being caught up in a bit of a scandal with the presidential race. Jair Bolsonaro has mandated the company pay out around $17 billion in dividends to the government and investors. This will be paid out via 2 dividends which come to around $2.62 per ADR share. The ADR’s have paid out in August but if you missed out on that, EWZ has semi annual dividends, one of which will likely be paid in January so investors can still take advantage of it.
Overall, it is a commodities and currency play. The real is the one currency which has gained against the dollar this year due to huge interest rate rises by Brazil’s Central Bank to stave off inflation, so if the presidential race doesn’t destabilize things, Brazil could end up being a winner this year and next.
China Small Cap
On a pure valuation and yield basis, despite all that the government is doing and has done, to deter investors, it’s just too hard to ignore. With a PE of 6.17 and a trailing yield of 6.58%, valuations or profits would just have to have meager 5% returns to make this ETF very attractive compared to other sectors. Given the growth that small caps have the potential for, this doesn’t seem like a wild assumption. It’s rare you see small caps in any market with these valuation figures, it shows you how spooked investors are about China. But when things are at their worst, that is when the big money can be made.
Chile
The next pick was a tough one for me. The valuation and yield of Colombia was attractive but having worked with both countries before, I know the capital markets and adherence to trade is stronger in Chile than Colombia. Again, both are quasi commodity trades with Chile depending heavily on copper prices but the ETF also benefits from lithium producers, banks and beverage makers.
Currently, both countries are seeing political turmoil in addition to having weakening currencies. Chile recently rejected a proposed new constitution and both countries have elected leftist presidents which has sent investors clamoring for the door. In neither case do I think they will take it to extremes like Venezuela, but the rejection of the constitution in Chile gives me hope that voters are looking for a middle ground and continued stability of the economy. This is what helped push me to choose Chile over Colombia.
Europe Small Cap
This was a tough choice between the Euro small cap and the Germany small cap. I’m the end, I opted for the Euro small cap due to its dividend yield and the range of countries it can offer compared to Germany.
To add a bit to the attractiveness, I also broke out the 10 year annual return next to that for the small cap ETF’s. Germany’s small caps returned an impressive 9.87% annually over the past 10 years which makes their valuation all that more surprising. Here though, I opted again for the higher yield and wider breadth of the European small caps. The yield of 4.26% is just too attractive for small cap shares and it provides access to companies across Europe, which includes the UK and Switzerland.
Australia
This again was a commodity play. Australia has world class mining company BHP Group and a number of different smaller producers which have taken advantage of the run up in prices. Yet the potential downside here is the level of demand of the global economy. A global slump is no good for commodity prices and in this type of scenario, Australia could suffer. The financials are also a big part of this ETF which help it offer a strong dividend yield.
At the end of the day, it was the weaker currency, commodities and a relatively sophisticated financial system that made Australia a pick for me despite it having a PE which was relatively higher compared to the group.
India
India again is my sleeper pick here despite the high valuation. A while ago, I featured India as having one of the only national market returns which rivaled the US over the last 10 to 20 years and it hits all the marks which you want in an emerging market: a democracy which gives its citizens relative freedom, world class IT companies, heavy industry and a young and growing population. All this comes with high expectations. The ETF has a PE of 23.94, higher than the US, but the large players are paying out huge dividends at the moment and that part of it kept my interest. While the focus during the past 20 years has been on the growth of China, I believe India has some of the greatest potential for the next 10-20 years and barring any great war or disaster, I would expect more of the same.
Conclusion
Markets have moved downwards since I first researched this post so the valuations have only gotten better. Keep in mind these are all long term plays for those that already have a core diversified portfolio. If you have the luxury of being able to stomach some big swings and have a patient timeline, some of these markets may offer some great returns in the coming 5-10 years. It’s not the hot stock advice that many are looking for but investing when there is blood in the streets is where the best money is often made.
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