International Stocks Due for a Comeback?
Valuations abroad are compelling. Here's where our pros have found opportunities.
Key takeaways
After more than a decade of underperformance, international stocks have recently offered significantly lower valuations than US stocks.
Opportunities have arisen in Europe due to the continent's renewed focus on energy independence and defense spending.
Emerging markets could also be an attractive destination for investors, thanks to young and growing populations, plus valuations that are even lower than those in developed markets.
International stocks were not exactly the hot place for investors to be in the past 10 to 15 years—a period when US growth stocks such as the so-called "FAANG" group of companies dominated market leaderboards.
But market leadership has a way of shifting every so often. After those years of underperformance, valuations abroad now look quite attractive compared with US stocks. In fact, in part due to those valuations, Fidelity's Asset Allocation Research Team forecasts that international stocks will outperform US stocks over the next 20 years (read more about our international economic outlook). Foreign stocks outperformed their US counterparts in the fourth quarter of 2022, a pattern that has continued thus far in 2023.
Here are some of the specific areas of opportunity that Fidelity's pros have recently found—both in developed and emerging markets.
The price is right
International stocks have generally lagged US markets since the financial crisis of 2008, and that prolonged period of underperformance has created attractive valuations.
"Relative to their own history and to US counterparts, international stocks look cheap," says Jed Weiss, manager of Fidelity® International Growth Fund (FIGFX). Weiss notes that this holds true almost no matter how one measures valuation—whether with price-to-earnings ratios, price-to-book ratios, dividend yield, or cash-flow yield.
The picture in emerging markets is also bright. Valuations in less-developed countries are even lower than in developed ones and economic growth is significantly higher. The reopening of China, the world's second-largest economy, after long COVID-induced lockdowns, has created attractive investment opportunities for both Chinese firms and international companies selling goods and services into the China market.
After crisis, rebuilding stronger
Russia's war in Ukraine not only created a human tragedy, but also triggered an energy crisis in Europe. "Europe was very dependent on imports of oil and natural gas from Russia, which were secure but untenable," says Alex Zavratsky, manager of Fidelity® International Value Fund (FIVLX).
A new European focus on energy independence has unleashed a surge in capital spending for energy security across the continent. This includes seeking new suppliers of gas and oil around the globe, construction of new facilities such as liquefied natural gas terminals, and a redoubling of efforts in domestically produced renewable energy sources like windfarms, solar power, and battery storage technology.
Examples of major players in this energy transition include TotalEnergies SE (TTE), an integrated French oil and gas major with a large renewables business, and Germany's RWE AG (RWEOY), a leading generator and supplier of electricity from both renewable and conventional energy sources. Industrial gas and engineering firms, which are involved in carbon sequestration, the production of clean hydrogen, and the liquefaction of gas, are another type of potential beneficiary. Linde PLC (LIN) has illustrated this theme in the highly consolidated industrial gas industry.
The war in Ukraine has also created renewed interest and willingness across Europe to invest more in defense. European countries including Germany and France have recently announced large budget increases in defense spending, which could provide potential opportunities for certain defense contractors. An example of a company that operates in this space is Britain's BAE Systems PLC (BAESY), Europe's largest defense contractor.
Capitalizing from pandemic disruptions
While COVID triggered a sharp economic downturn in Europe, it also disrupted competitive dynamics in certain industries—which some companies were able to seize on to take market share.
Weiss notes that the pandemic and ensuing economic contraction led to significant industrial restructuring in Europe that created attractive investment opportunities among businesses that emerged intact and even stronger.
For example, France-based Lectra (LCTSF)—a technology company that serves fashion, furniture, and automotive industries—was able to acquire its top competitor during the COVID crisis. This allowed the company to expand its dominance of the automated fabric and leather-cutting equipment and software industry. Madrid-based Amadeus IT (AMADY), a travel-related software outfit, used its strong balance sheet to wrest market share from its 2 major competitors upon the collapse of travel and tourism during the pandemic. And finally, France's Safran (SAFRY), which manufactures engines for civil and defense aircraft, used the crisis as an opportunity to slash costs (which can be challenging in a country where government and society often don't look kindly on corporations that lay off workers).
Value and growth in emerging markets
One of the main attractions of investing in emerging markets is that, literally, they're where the people are. John Dance, manager of Fidelity® Emerging Markets Fund (FEMKX), says that developing countries offer an attractive combination of young populations, strong growth in middle-income households, and expanding economies. Markets for many products and services that are already saturated in the US and other developed economies tend to be underpenetrated in developing countries.
Take the 1.4 billion people of China, who are exiting a lengthy period of quarantine with abundant pent-up savings and demand for consumption. Pinduoduo (PDD) and Hong Kong-based AIA (AAGIY) illustrate the types of domestically oriented businesses that could potentially stand to benefit. Pinduoduo, which serves 900 million users, operates an e-commerce platform targeted at less-affluent, price-sensitive consumers. AIA sells life and health insurance policies in China (and Southeast Asia), where insurance penetration rates are extremely low compared to those of Western countries, according to Weiss.
India also has a population of 1.4 billion, but the opportunities are somewhat different since the South Asian country is generally less developed than China (but growing faster than China in recent years) and with a younger demography. Political stability and growing fiscal strength at the federal government level are contributing to major investments and improvements in housing and infrastructure. Companies that have exemplified this investment thesis include Housing Development Finance Corp. (HDB), which provides mortgage financing, and Reliance Industries (RLNIY), a diversified conglomerate with large businesses in energy, telecommunications, and retailing.
Dance has also found opportunities beyond the major emerging markets of China and India. In a variety of markets, he's found companies that meet his criteria of strong management teams, long-term growth prospects, and improving product quality and customer service. Companies that have illustrated this focus are as disparate as Taiwan Semiconductor Manufacturing (TSM), the world's largest computer chip foundry; Localiza Rent a Car (LZRFY), Brazil's biggest car-rental company; and Mexico's Becle (BCCLF), the leading tequila distiller, with brands including Jose Cuervo.
The backdoor to emerging markets
Another way for investors to tap into swelling industrial and consumer demand in developing countries is through products and services sold by companies based in industrialized nations.
For example, Weiss's preferred vehicle for exposure to the Chinese economy is through foreign businesses such as Japanese industrial companies that aggressively tap the Chinese market. Developing countries (including China) are also large and growing markets for prestigious luxury goods brands. France's LVMH (LVMHF) and Hermes International (HESAF) are 2 owners of powerful global brands that have illustrated this theme.
Regions not to neglect
It may be too soon to anoint international stocks as the new market leadership, but there is good reason to believe that overseas returns could remain healthy. Investors may want to consider keeping some exposure to foreign markets in their portfolios for returns potential and diversification.