The cat's out of the bag: U.S. stocks are the new catnip, foreign equities more like cat litter. The U.S. has stimulative deficit spending including the recently approved payroll tax holiday, high productivity, and extremely competitive, globally sourced companies.
Meanwhile, emerging markets are labouring under an inflation scare.
Read more: Emerging markets have had their day - for now
Europe consists of countries that have been bailed out, countries that will need to be bailed out, and Germany. (The rest of northern Europe's pretty cozy too, but there's no arguing that the European Union has major structural problems that will need to be tackled sooner rather than later.) Australia's flooded and soggy in the financial sense, too, as a result of sky-high house prices and consumer debt. Japan is still Japan, notwithstanding early signs of a revival. China's got wasteful government meddling and the resulting construction bubble. Russia's a one-trick pony fired by oil and corruption. Mexico is barely governable, thanks to drug cartels. Everywhere a potential investor turns, troubles, and risks seem to abound.
Zigging as the Market Zags
The seemingly fashionable preference for U.S. equities is actually a contrarian call, based on the behaviour of U.S. mutual fund investors. Since the beginning of 2007, they have withdrawn $318-billion (U.S.) from domestic stock funds, while plowing $150-billion into overseas equities.
So add another danger to the list of those lurking overseas: that if investing preferences ever truly reverse, plenty of late-arriving cash could flow out of overseas markets. Add in the fact that so many of the most popular ETFs hold the same widely known foreign stocks, and you have a recipe for a scary moment or a terrible month or two if everyone should try to exit at the same time.
On the other hand, U.S. investors remain hugely underweight overseas equities relative to their economic and financial weight. So the question ought to be not how to retreat from overseas but how to remain there while outperforming those markets. And that requires shifting from those super-convenient ETFs to stock-picking among relatively unknown companies.
Toward that end, I have some picks ready to click. Or rather, I have the best ideas of the hottest international fund managers around. It's well-known that the hottest mutual funds tend to outperform the following year as well. I would bet that those manager's top bets also don't end up doing too shabbily. At least, and perhaps at most as well, top holdings of the top mutual funds are a good departure point in the search for strong stocks off the beaten track, because those are what ultimately drive the outperformance of those funds.
Fund: Janus Overseas Investment
Style: Large Growth
Distinction: Returned 19.3 per cent last year plus another 3.2 per cent month-to-date; manager Brent Lynn named Morningstar international stock manager of the year.
Top Holding: Li & Fung. The key supplier of merchandise to Wal-Mart and a bevy of other U.S. retail chains, Li & Fung is the world's top procurer of consumer goods and one inexorably moving up the value chain into brand management, at home and abroad.
For the purposes of this exercise, ignore trailing price/earnings ratio of 45. Focus instead on the 1.7 per cent annual dividend yield, the 20 per cent-plus return on equity and, most important, the 60 per cent return over the last 12 months, including 10 per cent so far this month. It's worth noting that Wal-Mart shares have broken out as well. As retail prices begin to rise, Wal-Mart and Li & Fung can expect more shoppers to head their way, and will have room to lift their own profit margins.
Fund: Oppenheimer International Small Company
Investment Style: Small Growth
Distinction: Returned 36.6 per cent over the last year, and 14.7 per cent annualized over the last ten.
Top Holding: Opera Software. For a $570-million company, Opera has a lot of irons in the fire. Its desktop browser maybe a static also-ran, but the mobile versions running on phones (and, now, tablets) are growing rapidly and taking share from the likes of Nokia in emerging markets.
Sales in the most recent quarter were up 35 per cent year-over-year in constant currency for this spinoff from the incumbent Norwegian telecom Telenor. Manufacturers like Sony and Philips have signed deals to bring the Opera browser to their Internet-capable television sets. The Olso-traded shares rallied from a low near NKR 16 in November 2009 to NKR 30 a year later. Now they've pulled back to NKR 27.40. The company pays a modest dividend, but if its mobile browser maintains its current growth rate the 0.6 per cent yield should remain an afterthought.
Fund: Royce Global Value
Investment Style: Midcap Growth
Distinction: Returned 32.8 per cent over the last year; five-star rating from Morningstar.
Top 3 Holding: Major Drilling International A contract driller for metal miners with operations in the Americas, Asia, Africa, and Australia, Major Drilling is coping with a major headache this year: It can barely train new hires fast enough to satisfy booming demand for its services.
Revenue in the most recent quarter was up 70 per cent year-over-year. The stock sells for less than 14 times next year's earnings. It's rallied 76 per cent since Aug. 31, including Wednesday's 5 per cent climb alongside the shares of its customers.
Fund: Oakmark International
Investment Style: Large Blend
Distinction: Manager David Herro named Morningstar's international manager of the decade (2000-2009). Five-star fund has returned 20.7 per cent over last year, second in its category.
Top Holding: Daiwa Securities. The stock is up 30 per cent since Nov. 1, even though the luckless brokerage is coming off three straight quarterly losses, the latest blamed on reduced commissions and sluggishness in mergers. Undaunted, Daiwa has embarked on an ambitious expansion drive across emerging Asia, recently opening an asset-management business in India and planning to increase its Asian staff outside Japan by 50 per cent in an 18-month period. The trailing price/earnings multiple of 40 looks steep, but Daiwa is lucky to have a multiple at all, and the 10 per cent market discount to book value is probably a better reflection of its current place in the financial pecking order. You also get a 2.6 per cent dividend to wait for the Japanese stock market to have a good year.
In a September interview on Oakmark's web site, Herro had this to say about the pick: "The financials weren't looking as cheap as they were a year ago and then we had the second quarter which enabled us to find good companies again that got beat up, especially those businesses involved in our very own industry, asset management. You'll see that we have a heavy flavor of asset management in the portfolios. Daiwa Securities, Credit Suisse, Schroeder's. These over the medium and long term are very good businesses. So we like asset management companies specifically because of the quality of the business models and the low price."
Herro must believe this is Tokyo's year, because he also has Canon and Toyota Motor in his top four holdings.
Fund: Templeton Foreign Smaller Companies
Investment Style: Small Value Distinction: Returned 25.8 per cent over last year, tops in its category.
Top Holding: Canaccord Financial The brokerage stock has rallied 43 per cent since Nov. 3, the day Canaccord posted a quarterly profit and cited dramatic improvement in its business since September. The stock is seen as a play on a pickup in mergers and acquisitions, notably among Canadian miners. Shares are priced at 12 times estimated earnings for the fiscal year that will start in April.
In a recent interview with Reuters, FINEX manager Bradley Radin also singled out the U.K. homebuilder Bovis as another especially promising holding. "We're at the tail end of quite a nasty bear market in UK housing," he said.
Fund: T. Rowe Price Emerging Europe & Mediterranean
Investment Style: Large Growth
Distinction: Among top emerging markets funds, with a 34 per cent return over the last year; returned nearly 15 per cent annualized over last decade
Top Holding: Sberbank of Russia. The over-the-counter US ADR for Russia's majority state-owned "savings bank" is up 60 per cent in four months, as high oil prices and pump priming ahead of the 2012 presidential elections stoke Russian growth. Annual profit of $6.2-billion recently topped internal estimates thanks to brisk loan demand and reduced bad-debt provisions. While Spanish banks scratch and claw for every euro, Sberbank's dollar bonds are selling like hotcakes in the West, pushing the yield down to 3.6 per cent.
Sberbank is also said to be eyeing a foray into investment banking. This may be tied to the coming raft of Russian privatizations, including a planned sale by the government of some of its shares in Sberbank. The bank is also considering acquisitions in Eastern Europe.
Igor Greenwald us global editor of MoneyShow.com