A solid first half for international equities
Can the pattern hold?
The tally from the most recent earnings season has been largely positive for international equities—a strikingly different outcome from the year-ago quarter. While we are mindful of the various uncertainties that await in the second half, several positive themes are emerging:
- Companies are going from strength to strength For the three months ended in June, constituents of the MSCI ACWI ex USA SMID Cap Index, which contains over 5,000 companies in 49 countries, reported consolidated revenue growth of 23.7%, the highest in more than a decade. Of course, that growth rate is flattered by a comparison to 2020’s second quarter, which felt the full effect from Covid-19 lockdowns. A more realistic comparison to second quarter 2019 sales shows that growth was up 7.5%, still well above the index’s flat median quarterly growth rate over the past decade. Encouragingly, many companies are reinvesting their sales windfalls into higher spending on research & development and marketing (as measured as a percentage of their sales), creating what we believe will be a flywheel of sustainable profitable growth over the coming years.
- Inflation is most likely a manageable headwind Pricing power is a critical attribute for commodity-consuming businesses such as Consumer Staples, particularly during periods of rising costs. While most of these companies revised their cost outlooks upward, they reiterated their original profit margin guidance as they are planning price increases and additional cost savings. All signs point to most commodity-exposed companies being able to navigate the current inflationary environment and end up relatively unscathed.
- Shareholders are being rewarded The V-shaped recovery of the past 12 months left many companies with excess capital. We were positively surprised by the large number that have announced a resumption of share buybacks or special dividend payouts. We view these as signs of disciplined management teams when it comes to capital allocation, a key driver of future shareholder returns.
- Earnings breadth is improving A stark contrast from a year ago is the current breadth of earnings strength. Last year’s earnings were bifurcated between “stay-at-home winners” and “reopening plays.” While many of the reopening plays, i.e., companies typically reliant on travel & leisure, continue to report challenged revenue growth, they have fortified their balance sheets and addressed their cost-bases, leaving them well positioned for an eventual recovery in their markets.
International outlook through year-end
In the third quarter, we expect a continuation of robust growth with the pace of growth gradually normalizing though year-end. Mindful of yet another delayed recovery following Covid-19 variant outbreaks, we believe some of the beaten-down yet larger, well-capitalized travel & leisure companies are ripe for a significant rebound.
Meanwhile, there’s no shortage of concerns, whether it’s peak growth, transitory or non-transitory inflation, Covid-19 variants or monetary and fiscal policy shifts. Given these uncertainties, we believe investors will be best served by constructing portfolios across a broader array of sectors and around companies with strong long-term fundamentals. Promising industries with long-term secular growth prospects include renewable energy and digital advertising.
As we have observed in the past, uncertainties often breed opportunities. With a large investment universe at our disposal, we continue to canvass our markets for new opportunities as we head into the second half of the year.