Recently, I’ve seen significant underperformance from “quality” stocks in non-U.S. developed markets. This is not surprising. New entrants who come into markets after a rally are nearly always afraid they have “missed it,” so rather than focusing on future long-term gains, they often respond by trying to find “bargains” that can yield a short-term payoff. Usually, this may involve buying companies that are highly levered into good macroeconomic news and that will pop more than will steady earners as that news comes through.
I’ve seen this phenomenon in Europe particularly, where in tandem with September headlines trumpeting “U.S. Investors Pile into European Equities,”1 the share prices of many companies with strong global franchises actually declined. This was especially the case with those who earn a significant portion of their revenues in emerging markets: consumer staples firms such as Nestlé, Unilever, Danone, Diageo, Pernod Ricard, SAB Miller and Heineken. Concerns over a potential near-term slowdown in emerging market growth produced the sort of binary overreaction that markets so often display: investors sold companies at valuations half-or less than half-of what their emerging market subsidiaries were trading.
In my opinion, focusing on the short term is tantamount to chasing the market. Trying to predict news flow and second-guess the reactions of other market participants is a good way to always be a step behind. Investors are better served by working to understand the potential long-term value of companies by looking for strong businesses that may create portfolio value for years to come. The companies to whom it makes sense to allocate capital include ones with good fundamentals, such as hard-to-replicate brands, strong market positions, effective business models, durable pricing power, consistently positive returns on invested capital and the financial flexibility of a strong balance sheet.
I actually agree that investors should be buying European equities. On a long term-view, good quality companies in Europe are modestly valued. With broad multiples at levels where we believe the market is assigning little value to “quality companies,” opportunities abound for patient, active managers who concentrate on fundamentals.
1Source: Financial Times, 9/8/13.
As of September 30, 2013, Oppenheimer International Growth Fund had 1.01% of its assets invested in Unilever; 1.01% of its assets invested in Danone; 1.23% of its assets invested in Diageo; 1.16% of its assets invested in Pernod Ricard; and 1.34% of its assets invested in Heineken.
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