Linda Duessel: Hello, and welcome again to the Hear and Now podcast. I'm Linda Duessel, Senior Equity Strategist at Federated Hermes, and today I'm joined by Martin Schulz, Managing Director of International Equity. Hello, Martin.
Martin Schulz: Hi, Linda.
Linda : Just to get started here. International. Do you believe that investors should increase their international allocation in the current environment?
Martin: That's a great question, Linda. Obviously the international stock markets go in cycles relative to the U.S., and the U.S. had a very strong run the last few years. We've obviously had a situation in which we've had dollar strength, which has been coupled or, I guess, provided by the China trade war situation. It's been helped by the corporate tax cut we had a little over two years ago. And it's been provided by probably the focus on the strength of the U.S. Economy. And we've seen this in years past. And so we usually see a five, seven, eight year cycle.
Martin: And in fact, we were expecting the U.S. dollar to weaken about two or three years ago. But with the corporate tax cuts, with some other factors like the China trade tariff situation, the dollar remains stronger. And so what that meant obviously is that particularly the emerging markets, but international markets in general, underperformed the U.S. Now we think we're, at some point, we're at a cusp, where that inflection point and things will change. We don't know when that's going to happen, but we're definitely getting closer to that end point.
Linda: To where the dollar is likely to weaken.
Martin: And a U.S. outperformance will likely end. And again, if you look at when we first started our fund, for example in the late nineties, it was a time in which obviously the fed was talking about exuberance. It was talking it was basically a NASDAQ bubble. The U.S. was the focal point for most global investors. And that obviously changed and the next decade, particularly the emerging markets, did very, very well from 2001 through 2011. And so we don't expect that same kind of retracts to happen, but we do expect that international will start to outperform relative to the U.S.
Linda: Yeah, and you did mention that the U.S. economy has done better than some of the others, and I wonder if valuations have really come down relative to history enough where it's worth looking outside the United States when we we're thinking maybe they're having soft landings instead of recessions that we were all worried about last year.
Martin: Now you bring up a very good point, Linda, in terms of valuations. Long term international relative to the U.S. valuations have been lower. But at the same time we've seen cycles where they've gotten closer. And so, particularly in Europe right now, which is the majority if you will of international investment outside the U.S. and developed market side, it's been very weak.
Martin: That's primarily been because the China trade war has affected Germany and in specific, but also the automobile industry which is affecting Germany. And so Europe obviously has Brexit issues. It has some other factors involved, demographic headwinds. But we feel now with the Euro at a much more competitive level, and where we're starting to see PMI is globally it start to bottom and start to rebound, we actually see that these more open economies such as Sweden, Germany, and the emerging markets in general will likely outperform.
Linda: Okay, well let's now look at emerging markets. They've been underperforming for the past decade. Is it finally their turn in 2020, and what is your longer term outlook for emerging markets?
Martin: So long term emerging markets were very, very constructive. Emerging markets obviously have demographic tailwinds. They've got some growth tailwinds. They have consumption tailwinds. And if you think about the emerging markets, the last few, we think of them as the bricks, if you will. Jim O'Neill's kind of view of a name for it who gave it to about 20 years ago. And in those bricks you had a situation which you had obviously Brazil and Russia being more commodity-based. And then India and China being much more consumption based and more service oriented. And we do see that dichotomy continuing. And so we are more constructive on the India's and the China's long term. Partly because of demographics of Brazil is an outlier there, because we also are very, very favorable towards Brazil equities as well.
Martin: But at the end of the day, this big shift from commodity producers to actual consumption stories is something we're starting to see. And so, for the longest time China was a market in which foreign direct investment was a big factor. And obviously manufacturing and exporting was a big factor. We're starting to see that change. I can tell you I've been going to China for over 25 years and for many years going to China meant buying some very good cheap, whether it's clothing or you can obviously export, whether it's Apple phones or a lot of things to the U.S. and elsewhere. That's now changed.
Martin: When you go to China, the prices are higher because obviously wages have increased the levels that are much more competitive. And so your starting to see actual interest in places like Vietnam. And so as we look at the emerging markets, we're looking at those markets that have the ability to grow, that have demographic tailwinds. And so places like Vietnam for example, are places where we started to invest the last few years.
Martin: But specifically, we use a top down country allocation approach, and we've noticed more recently that it's telling us to get out of the developed markets. So we're talking about Europe, Japan, and we've been overweight Japan for the last eight or nine years and start to look at the MENA region, Latin America and Southeast Asia.
Linda: Okay. Well now let's talk about styles. Growth has outperformed value for most of the past 10 years. Is it finally values turn? And if not, what environment does value need in order to outperform again?
Martin: Yeah, value is obviously underperformed the last 10 years. I think part of that has to do with the central bank, a use of quantitative easing and providing liquidity that's out there. You could also argue that value is underperformed because in such a low growth environment, everyone is looking for growth, and so that has not worked. I'm obviously been in this business for a long, long time. If I were to tell you right now that no, that something's going to change, then that's not the case. So we do think that value will return. The question is when, and we are starting to see, obviously we talked about the U.S. earlier relative to the international markets, the U.S. FANGs, those basically larger cap growth oriented internet companies are doing very well.
Martin: Those same companies, XUS, are also doing well. But that bubble, if there is one I should say, if those stocks do lead into a bubble like we learned in the late nineties with the NASDAQ in that bubble, then that may be a trigger point. So we can never say for certain what the trigger point will be. But at the end of the day, right now people are searching, investors are searching for growth and the way they get that is through some of the growth investors.
Martin: But I do feel that this big shift that we're seeing from commodity oriented into consumer, if you think of the ESG space for example, by luck or by hook, we're in a situation where we're tech heavy and healthcare heavy and not materials heavy and not heavy in those markets. Or, I should say in those sectors that may obviously be underperforming relative to the long term.
Linda: So still a growth regime.
Martin: We believe so.
Linda: And you mentioned, you like emerging markets, but can we drill down a little bit more and talk about what particular countries or regions that you're seeing some of the best opportunities for this year?
Martin: Okay. So we did mention obviously that our model is asking us to take some exposure out of EMU Europe, to say take some exposure out of Japan. But specifically what we're looking for are countries such as Egypt where the balance of payments has become very positive. We believe also the cycle is turning. Banks are doing very well, and we have a few investments in those arenas in those markets. So the middle East is a place we've been looking. Also Africa, in places like Kenya, we're starting to see some very interesting potential. And then really recently, Latin America and Southeast Asia are the two areas we're looking.
Martin: So specifically I mentioned earlier Vietnam. This is a market that's going to benefit from the acceleration of the move out of China into more markets that are lower wage levels. And so that will be Bangladesh as well. So we've looked at, hunted and pecked around at Bangladesh, as well. But I'd say Vietnam is interesting. Singapore also, which obviously a developed market but is also one that is looking interesting to some degree. And so then finally Taiwan, we're starting to see 5G be a big factor this year. And in meetings with corporate officials at CES this year, it became apparent to me that the 5G trend is a capping much faster. And so Taiwan and some of the outsourcers are going to be the big beneficiaries there.
Linda: Well, those are some very interesting countries that many of us don't have much knowledge of. And it seems everybody's talking about China, the second largest economy in the whole world. I noticed you didn't really mention that one at all. Steering clear while they go through their numerous issues?
Martin: No, we think actually China does have some long term opportunities and we've been invested there for a long, long time. As I mentioned, I've been going to China since 1987, so I've seen a lot of the changes over time. And our view right now in the emerging markets portfolios, for example, we are slightly overweight China in fact. And within our AquiXUS portfolio, we are also a slightly overweight China. And the way we've approached China is really by looking at those companies that have long term structural growth that are involved, for example, in the internet space, consumption space. But then also companies in the insurance space, for example, that are seeing markets basically benefit from a long term trend towards the Chinese consumer becoming much more interested in insurance and that sort of thing.
Martin: So we've seen massive growth on both the insurance and the consumption side, but we're staying away from the exporters and some of the companies that we feel longer-term may have some issues and obviously some debt.
Linda: Okay. We've talked areas of the world, we've talked styles. Now let's talk about sectors. Do you have any preferred sectors for international equity investing this year?
Martin: So, by custom we are overweight technology and healthcare by way of our process and philosophy. And so that's where we generally do find some of our best ideas. So we will continue to look within technology and healthcare. And particularly in the healthcare space, we're finding opportunities in biotech in Europe, but then also on the devices and the medical device side really throughout the world. And so even the emerging markets where emerging markets have a very low exposure to the healthcare sector, we're actually fairly largely overweight. Though that section, we'll continue to believe that particularly places like China where there are longterm as the Chinese economy, and I should say the demographic starts. 2015 was basically the peak of the employment cycle, and so we're expecting that healthcare is a place to look.
Martin: And then finally consumption. The one place as we travel around the world and our team visits a thousand companies a year, generally speaking, we are starting to see that consumption is strong everywhere. Regardless of where you go, whether it's in Thailand, whether it's in Switzerland, whether it's in Germany, even where manufacturing is weak, we are starting to see continued consumption strength. And so some of the consumption companies, we definitely see the discretionary consumption companies will continue to buy and invest in.
Linda: So good positive outlook for international investing going into 2020? One final question then, if I may.
Linda: What are some of the risks that concern you, which could derail a bullish outcome for international investing?
Martin: Well, you know Linda, there's always risk out there, and so we keep our finger on the pulse and we're meeting not just obviously with company management, but also with the central banks and other government entities around the world. And so, probably the two biggest potential concerns for us would be a very, very strong dollar. And that would mean obviously a flight to safety to some degree. And then also in somewhere related a very high inflation rate. But you know, we've been doing this for 23 plus years and we've seen the different cycles.
Martin: When we first started our strategy, for example, it was in the throws of the Asian economic crisis. And so we've learned to really view risk as something we really put emphasis on and make sure that we're looking at companies and countries that have low valuations but growth, but then have the least amount of risk. So despite a lot of obviously risk events that occur generally throughout the different cycles of the many years. Again, we've been doing this for 20 plus years. We've seen wars, we've seen geopolitical events, we've seen elections, populism, viral, SARS for example in 2003. Those events are one-time events and we're invested in those markets that are undervalued, have the least amount of risk and have the growth that we're looking for, for the long term.
Disclosure: Views are as of February 6th, 2020, and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector. International investing involves special risks, including currency risk, increased volatility, political risks, and differences in auditing and other financial standards. Prices of emerging market securities can be significantly more volatile than the prices of securities in developed countries, and currency risk and political risks are accentuated in emerging markets. Due to their relatively high valuations, growth stocks are typically more volatile than value stocks. Value stocks may lag growth stocks the performance, particularly in late stages of a market advance. Federated Global Investment Management Corp. 20100-14 (2/20).