When we disaggregate the contributions to international equity returns this year, we see that the biggest detractors have been the contraction of P/E multiples, and currency weakness against the U.S. dollar. Earnings per share growth has been a positive driver for international company stock performance in 2018.
So, what does this tell us?
This data indicates that the response to internationals has been driven not by the economic fundamentals of these international markets and companies, but by a reaction to the recent trade conflicts and tariffs, whose effective economic impact has not yet materialized. The selling of these international companies has caused the price to contract while earnings have simultaneously been growing, a sign of forced selling.
A prime example of what encapsulates the factors at play in this most recent pullback has been the performance of a number of companies in the Chinese technology sector that have maintained strong quarterly earnings growth through the third quarter of 2018, yet have seen their valuations cut by 35% in 2018. There is a strong disconnect between the company’s earnings and economic prospects and their stock price performance, driven not due to any fundamental differences in these companies’ economic position, but of fears regarding uncertain outcomes of these trade wars.
Currently, European, Japanese, and emerging market equities are trading below their 25-year historical average P/E ratios, whereas the U.S. is slightly above its historical average P/E ratio. The valuations overseas continue to look more favorable relative to those in the U.S. In volatile times like these, tried and true investing approaches involve staying the course, recognizing good valuations when we see them, and not overreacting during periods of volatility. It may be a couple of months or as long as 18-24 months before valuations from internationals normalize.
You may ask, should we wait to invest until everything has worked out? No, because the first positive results usually yield the most significant returns.
If you have any questions about this, please reach out to a member of the Willis Johnson & Associates team.