Growth is in pockets
Stock picking is going to matter more than in the past. Last year, we had massive divergence in performance for the first time in years: The U.S. market was up 30% while the Brazilian market was down 30% in U.S. dollars. I think this dispersion is going to continue, so the case for active management is going to be as robust as ever.
Growth is in pockets, and it’s scarce, so you should be willing to pay more for it.
Three pockets: Europe, Japan, and the U.S.
There are three places I’m investing incremental capital: the U.S., Japan, and certain companies in Europe with big emerging market exposure.
I’ve been surprised by the magnitude of the rerating in Europe. Over the last 18 months, more than 100% of the total return in Europe has been explained by higher multiples. You actually had cuts in earnings estimates while the market posted big gains.
In Europe, I think it has become very difficult to find domestically oriented, high-quality companies at reasonable prices. Investors have bought the banks, and they’ve become expensive. Things are moving in the right direction, but I think the market’s way ahead of itself.
The exceptions are European companies, such as British American Tobacco, that get a lot of revenues from emerging markets. Some of these stocks have been hurt by investors’ worries about emerging markets’ economic problems. But revenues for some of these companies may be resilient, so, with their current valuations, there may be buying opportunities.
In Japan, there is finally inflation and positive economic momentum. It looks as if the next leg of growth there could come from corporate Japan. A lot of Japanese corporations have built up huge cash balances, and now that the yen has weakened, they’re making a lot higher margins. I think we’re going to see the government promote spending by lowering corporate tax rates in exchange for more hiring. If we get reflation, companies that profit from higher prices and increasing assets could benefit. I have invested in leasing company Orix and financial firm Sumitomo Mitsui Trust Co.
We’re in a sweet spot in the United States. The economy’s gradually improving. Corporate profits are at an all-time high, and companies are much more focused on returns on capital—they’re only making investments when they can get valuable returns. And there’s still a lot of slack in the economy, which means economic activity can pick up without causing much inflation.
Opportunities in emerging markets
I’m focusing on emerging markets such as Mexico, which has made some tough economic decisions and put itself in a better place as a result. Mexico also benefits from its close ties to the United States.
Contrast that with Brazil, which is looking somber for the next couple of years. Wages were up 8% per year on average over the past decade, and manufacturing productivity was actually down by about 1% per year. That’s not sustainable. So, in Brazil, I have focused on low-priced staple items including telephones and toothpaste, rather than automobiles or other high-priced discretionary items.
In China, GDP is supposedly growing at 7% or 8%, but it’s not translating into profits. For example, hotels are one of the most economically sensitive sectors, but hotel revenues last year were down, largely due to government cutbacks. Sales of menswear were down as well.
I think the winner is the Chinese consumer. The labor pool is shrinking, which means wages will go up. As the Chinese consumer gets wealthier, they’ll travel more, so I have been looking at airports in Thailand and Sydney. I have also been interested in Internet companies there, such as real estate Internet company SouFun.
I’m also positive on countries in the ASEAN region, particularly the Philippines and Indonesia. These countries tend to have relatively large domestic economies, high savings rates, low loan-to-GDP ratios, real economic growth of 6%, and inflation of 4% or 5%.
Sub-Saharan Africa is another growth area. A lot of South African companies are well run with good corporate governance, have a track record of operating in tough environments, and stand to benefit from growth in that region. I have been looking at companies that include Shoprite and Guaranty Trust Bank.