Broadening the investment opportunity set to overseas companies can potentially provide significant benefits to a diversified equity portfolio, and we believe there are several trends that could continue to support non-U.S. equities:
- The global disinflation narrative is intact. While the moderating trend in inflation in the United States had plateaued at the start of the year, there have now been two consecutive months of softer price increases, paving the way for a potential U.S. Federal Reserve (Fed) rate cut in September. Many economies overseas are ahead of the U.S. on this front, with headline inflation in the Eurozone, Germany, the U.K., and Canada now at 2.5%, 2.2%, 2%, and 2.9%, respectively, based on reports from the European Union and respective national governments. As a testament to this progress, the European Central Bank (ECB), Bank of Canada, and the Swiss National Bank all reduced their key policy rates by 25 basis points (bps) in June. The end of a historic, global rate-hiking campaign, now followed by the early stages of its unwinding, should continue to support risk assets broadly.
- Growth remains healthy outside of the United States, and consensus forecasts are for the world economy to continue growing at a 3.2% pace during 2024 and 2025, according to the International Monetary Fund. While growth in Europe is not strong in absolute terms, it is in positive territory and has been surprising to the upside. Europe has been helped by a decline in natural gas prices, which have receded to levels last seen before the invasion of Ukraine in February 2022, and a pickup in manufacturing activity.
- Corporate earnings in Europe, as measured by the Stoxx 600, are expected to grow approximately 6% for all of 2024 and 10% in 2025. Earnings for emerging-market companies are also expected to advance strongly, by approximately 17% in 2024 and 16% in 2025 (based on the MSCI EM Index). (Earnings forecasts are as of July 15, 2024.)
- There are several secular drivers that should benefit companies outside the United States. Perhaps the biggest of these is the increasing adoption of AI. While companies like NVIDIA, Meta, and Alphabet dominate AI-related headlines today, as AI investment continues, and the technology grows and is used more widely, the pool of AI beneficiaries will grow as well, especially in Asia. Japan is an economy that is very much centered around technology and robotics, so some of the same trends around AI that are benefiting the U.S. are benefiting Japan as well. Smaller companies that play in other parts of the supply chain outside of chip manufacturing, e.g., servers, warehouses, cooling systems, etc. stand to benefit, and many of them are domiciled outside the U.S. Examples include Taiwan Semiconductor, SK Hynix, Kokusai, and Hon Hai.
- One other secular trend to watch is the increasing use of GLP-1 drugs to treat both diabetes and obesity. This market is expected to grow at a rate of more than 20% annually and reach $133 billion worldwide by 2030, based on a report cited by the American Hospital Association. Currently, this total addressable market is being served largely by two companies—Novo Nordisk and Eli Lilly, based in Denmark and the United States, respectively. Other companies in Europe have been eyeing the space, with Zealand Pharma (also based in Denmark) showing positive weight loss results in its proprietary drug Petrelintide.
An Active Approach to Finding Strong, Global Businesses
As we have seen, both cyclical and secular drivers present a strong case for global equities. But what might be the best way to access the asset class? Although indexing is a popular way to invest in equity markets, it is not a great strategy for international markets. With such a broad playing field, owning the market means also owning companies that have unattractive fundamentals—including, but not limited to, low returns on invested capital, negative earnings and/or dismal or non-existent earnings growth, and high leverage.
As such, we recommend a heightened level of scrutiny to global equity investing that focuses on finding global businesses with sustainable competitive edges. These advantages allow firms to exhibit strong quality metrics, such as high returns on capital, free cash flow, and solid margins, which are typically indicative of businesses with a competitive “moat.”
The importance of earnings should not be understated. While many observers thought the rally in NVIDIA’s shares last year was overdone, the advance has continued through mid-2024 as the company’s earnings growth and return on invested capital (ROIC) has matched the rise in the stock price. We find the same pattern outside the United States. Over the last decade, the top decile (top 10%) segment of the MSCI ACWI ex-USA Index, based on annual ROIC growth, outperformed the bottom decile by 51.8% (see Figure 2).
