Finding Value among Stretched US Valuations, Market Dislocations
In recent years, US market strength has lifted markets globally, despite recent bouts of market volatility. According to Templeton Global Equity Group, that US market strength has led to a widening valuation gap between US and global equities. As global markets focus more on US economic expansion and a series of macro risks, the group shares where they are looking for pockets of opportunity outside the United States.
Third-Quarter Market Recap
The market focused on a few macro risks in the third quarter. Concerns about trade wars, Brexit negotiations, the Italian budget, emerging-market volatility and interest rates seemed to escalate during the period.
In retrospect, it wasn’t all risks. The market also focused on recent strength in the US economy, corporate earnings and, until recently, the leadership of US technology stocks.
That said, the euphoria around the US gross domestic product (GDP) growth in the second quarter—which came in at a solid 7.6% (in nominal terms)—turned into concerns about how long this economic expansion could continue and, importantly, the pace of Federal Reserve Board (Fed) interest-rate hikes.
Valuations Appear More Attractive Outside the United States
In the third quarter, US economic strength led market sentiment, a pattern we have seen in most of the last few years. This has resulted in a widening valuation gap between the US market and the rest of the world.
We believe this widening valuation gap implies a much more favorable backdrop for long-term returns outside the United States. Expectations are not only lower, but the economic cycles are lagging behind the United States.
We think there is an opportunity to close the valuation gap between the United States and cheaper international markets in coming years, thereby closing the performance gap as well. Many of the US companies we analyze are reporting margins that look to us to be very close to peak levels, and corporate tax rates are currently at the lowest levels in decades.
That makes it a bit more difficult for us to find value in some US companies. So, while we are able to find some individual bargains in the United States, we are finding greater value abroad.