We’ve been arguing for the last year that US-based investors would be well served to overweight foreign versus domestic equities. In this post we’ll dig into that topic a little deeper to try to convey a few of the company specific fundamental drivers of our foreign vs domestic call, especially as they relate to one of our favorite markets: Japan. Readers should note that in each of the charts below we present bottoms up aggregated data (i.e. summed up from company financial statements) for the three developed market regions in our global equity universe, excluding financial companies. DM Americas (essentially the US) is represented by the dark blue line, DM EMEA is represented by the red line and DM Asia (essentially Japan) is represented by the light blue line. Our developed market global equity universe includes the largest 85% of listed equities in 22 developed market countries around the world, which is a similar methodology employed by the large index providers.
Over the last several years Japan has become a very interesting place to invest. Before we get into the whys and wherefores, let’s just start with the observation that margins and returns are structurally improving in Japan, but are structurally range bound or falling in the US and in Europe. The first two charts below depict the gross margin and ROE. The gross margin for Japanese companies has risen by 30% since 2000 and stands near an all-time high. The gross margin for American companies is range bound and that for European companies has fallen by 10% since 2000. Meanwhile the ROE for Japanese companies has more than doubled from 2000 levels compared to flat profitability for American companies and declining profitability for European companies.