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Over the last 10 years, US large-capitalisation (large-cap) equities have experienced a tremendous run, with the relative strength of US dollar (USD) helping the cause.1 However, if you look back 10 years prior (2000–2010), you’ll find that international markets delivered better returns.2
Looking forward, here are three key reasons why we believe the case for international markets is, once again, strong:
Lower valuations: International equities have relatively lower valuations versus US equities.
Economic recovery: We believe countries that are taking a more measured approach will still see the benefits of their stimulus packages, but that the market’s response will take longer to materialise. Moreover, there are countries outside the United States that have been a better model for handling the COVID-19 crisis (including smart lockdowns, testing and tracing strategies versus a disarray of conflicting policies). Other countries managed to act early to systematically control the pandemic and have experienced less disruptions, and appear better positioned to bring their businesses and economies back. In addition, we believe these countries remain vigilant with continuous enhancements to face the evolving virus and continue to benefit from centralised strategy, creating a more sustainable recovery with less risk for regression/relapse.
Foreign currency: During the worst of the COVID-19-induced downdraft, we witnessed flight-to-safety behavior driving USD appreciation relative to many foreign currencies. Most notably, by the end of the first quarter 2020, we saw the USD appreciate 29%, 28%, 26% and 24% against the Brazilian Real (BRL), South African Rand (ZAR), Russian Ruble (RUB), and Mexican Peso (MXN), respectively.3 After that initial rush, we expect foreign currencies to recover versus the USD; in fact, we saw signs of recovery against the Australian dollar (AUD) as well as against developed European currencies, and expect that other foreign currencies will likely start to strengthen, providing extra tailwind to international investing.
The Case for Single-Country Allocation
For international exposure, many investors look for a diversified fund/investment vehicle that tracks broad market indices, such as the FTSE Developed Index or the MSCI Emerging Markets Index. However, recent market events have created new—or amplified existing—opportunities for investors to express views on specific countries they feel may be better positioned for the future. For example, the COVID-19 crisis continues to drive rethinking of supply chains—with greater focus on shorter chains and less globalisation, which will likely result in continued wide dispersion of single-country returns.
Disaggregating international exposure allows investors to assign a different weight to specific countries relative to their respective weighting within a broad market-cap weighted index. For example, if an investor had reallocated MSCI EM Index exposure with an additional 5% exposure to Taiwan and reducing a corresponding 5% exposure to Brazil, while keeping all other countries allocation the same, that investor would have experienced an additional +3% performance pickup over the one-year period ending August 14, 2020.4
Let us start by examining specific COVID-19-driven impacts by theme and identifying potential investment opportunities we see as a result of each:
1. Decreased globalisation
The pandemic has exposed deficiencies in global supply chains, pushing people and companies to rethink their processes. Many countries will likely shift to having more closed, less global and shorter supply chains. Many are also putting focus on improving operational agility in order to more nimbly respond to ongoing market turmoil for the foreseeable future.
• Opportunities: Decreased globalisation would mean local, in-country supply chain partners will supplement or replace remote ones, and intelligent software technologies will be increasingly adopted to optimise supply chain operations.
2. Increased sector return dispersions
We have seen the pandemic impact sectors and industries differently throughout 2020 and expect to continue to see this through the recovery, for example, consumer discretionary, airlines, energy, commercial real estate, etc., could take years to recover (possibly years beyond COVID-19 recovery) and may look very different as they are forced to evolve.
• Opportunities: Many countries have evolved to be more heavily weighted in certain sectors. As we consider investment opportunities, this may be an opportunity to identify potential return dispersions, as is considering countries with net imports who are capturing the shift to local demand versus foreign.
Safety precautions and travel restrictions have limited in-person meetings, which has necessitated a faster adoption of secure digital transactions. Moreover, in a world that is changing each day, increased digitisation of information helps to identify large scale economic and public health trends, which will be vital to the development of business and health-related solutions.
• Opportunities: Software that facilitates digital document-signing for contracts, financing documents or other legal documents is more important than ever. There is also an increased demand for digital health care solutions that consolidate and transfer health care data. Finally, the e-payment space has already seen a surge in demand as a result of the need for contactless transactions.
4. Forced innovation
Ironically, some of the innovations taking place right now were forced by recent conditions, yet the impact could be ever-lasting. Developments that seemed unlikely before, such as remote working for certain roles, have now been proven as not only possible, but effective.
• Opportunities: This new “work reality” has obvious implications for remote working equipment and cloud computing technologies, but there also is an indirect impact on office real estate, restaurant and food supply chain and service amenities. As such, we anticipate online retail commerce platforms and technologies that facilitate more of a “B2C” model may continue to thrive post-COVID-19.
Taking Advantage of Post COVID-19 Emerging Themes Driving Countries
Coming out from the pandemic, when lockdowns are removed and businesses try to get back to “normal,” we expect that everything will not go back to as was before. There have been major shifts in supply chains, labour movement and varying policies that will create further differentiation in how each country will perform. Interestingly, the majority of the countries we anticipate performing well are in Asia, notably South Korea and Taiwan, due in part to their prior SARS recovery experience. These countries also benefited from relatively stable foreign currency versus the USD.
• The FTSE South Korea RIC Capped Index has a large technology sector allocation (37%), one of the prime beneficiaries of the pandemic.5
• Large exporter to China, with trend of shortening supply chain, may get benefit from Asian neighbours.
• Advanced handling of COVID-19 with contact-tracing technology.
• Likely to benefit from restructuring of many chaebols (Korean conglomerate with complex interrelationships), potentially paving way for better governance.
• The FTSE Taiwan RIC Capped Index has a large allocation to the technology sector (42%), one of the prime beneficiaries of the pandemic.6
• The country has been a world leader in handling COVID-19.
• Significant tie to US technology.
• Sophisticated manufacturing capabilities well-adapted to changing supply chain. Looking outside of Asia, we believe Switzerland may emerge as a leader amid COVID-19, experiencing minimal exposure to trade tensions and political risk given its reputation as a neutral safe-haven market. The country’s benchmark FTSE Switzerland RIC Capped Index is also overweight defensive sectors (over 50%).7
In conclusion, we believe single-country allocation can create an opportunity for investors to thoughtfully reposition portfolios to allocate to specific countries they believe are likely to come out better as the world is trying to find its new “normal.”
What Are the Risks?
All investments involve risks, including possible loss of principal. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions.
Special risks are associated with foreign investing, including currency fluctuations, economic instability and
political developments. Investments in developing markets, of which frontier markets are a subset, involve heightened risks related to the same factors, in addition to those associated with these markets’ smaller size, lesser liquidity and lack of established legal, political, business and social frameworks to support securities markets. Because these frameworks are typically even less developed in frontier markets, as well as various factors including the increased potential for extreme price volatility, illiquidity, trade barriers and exchange controls, the risks associated with developing markets are magnified in frontier markets.
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1. Source: Bloomberg, August 2020. The S&P 500 Index returned 227.5% vs. MSCI ACWI ex-US Index, which returned 40.53% from 31/12/2010 to 14/08/2020. Indices are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator or a guarantee of future results. See franklintempletondatasources.com for additional data provider information.
2. Source: Bloomberg, August 2020. The S&P 500 Index (SPX) returned 15.07% vs. the MSCI ACWI ex-US Index, which returned 71.53% from 29/12/2000 to 31/12/2010. Indices are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator or a guarantee of future results.
3. Sources: The World Markets Company, Reuters, August 2020.
4. Indices are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator or a guarantee of future results.
5. Source: Bloomberg, August 2020. Indices are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator or a guarantee of future results.
6. Source: Bloomberg, August 2020. Indices are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator or a guarantee of future results.
7. Source: Bloomberg, August 2020. Indices are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator or a guarantee of future results.