It’s time to look beyond the United States to Europe and Japan
Japan has similar, if not more intense, problems with its corporate philosophy and structure. Old-fashioned management, dyed in the wool, has hardly been useful and cross-shareholdings have created a love-in that is not favorable to shareholders. But there are some unusual companies that have unique strengths. An allocation will barely dominate a portfolio but offers a very different perspective than the US.
How many investors can nominate the top five companies by market capitalization in each region? Most would get the S&P is quite right with Apple, Microsoft, Amazon, Alphabet (parent company of Google) and willingly names others probably in the top 20. It will not be the same for Europe or Japan. These markets are much less concentrated. The top 10 in Europe make up around 16% of the total index weight, Japan around 21%, while the US has over 30% in just 10 stocks. It’s no wonder that when one or two of the US companies disappoint on high expectations, the index is more affected than other regions, ignoring other influences.
In the meantime, macroeconomic factors could also favor Europe and Japan. Monetary policy should remain much looser with delayed rate hikes, and the impact of duration on stock market valuations in these regions is not as pronounced as in the United States, as they do not rely on very long-term growth forecasts.
At the headline level, the valuations of Europe and Japan are much more pleasing to the eye than those of the United States. The analyst of this data will attribute much to compositional issues, again noting the high weight of computing compared to elsewhere. But even taking this into account, the valuations of these indices remain well below those of the United States.
Expected earnings growth isn’t all that different either. US companies are facing steep cost increases while Europe is benefiting from rising commodity prices and rates and structural shortages in Japan that are allowing some price increases.
In the longer term, the differences may persist. Investors looking for energy-transforming industries will find plenty of options in Europe, itself ahead of the game in aiming to reduce its carbon intensity. Japan has a unique set of highly advanced materials, new era industrial enterprises and even consumers.
It would be brave to switch to a purely bullish mode for European and Japanese equities. Nevertheless, the case of S&The dominance of the P500 is no longer clear. Regional allocations are often rightly rejected because the corporate entity matters more than its listing domicile, but the default could result in more outside the United States simply through stock selection.