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Early this year, concerns over higher inflation and interest rates led to a rise in volatility, and global equity indices ended the quarter down in most markets. However, despite the weak start to 2018, the Invesco International and Global Growth team sees positive signs among a number of important Earnings, Quality and Valuation (EQV) measures. The recent spike in volatility is a welcome development for investors like ourselves who emphasize valuation as a critical input to risk and return potential.
The quarter in review
In dollar terms, the MSCI All Country World Index fell by 0.96% in the first quarter. US stocks (represented by the S&P 500 Index) declined by about 0.76%. On either end of the spectrum was Europe, with the MSCI Europe Index down 1.98%, and emerging markets, with the MSCI Emerging Markets Index up 1.42% —boosted by Latin American equities and Brazil, in particular.1
Cyclical areas of the market, including many blue chip technology shares, felt the brunt of the share price declines. Growth continued its outperformance over value, but by much smaller margins than seen in the fourth quarter. In general, small caps outperformed large caps in most regions.2
What we see through our EQV lens
Consensus estimates for growth are healthy, with the MSCI All Country World Index expected to deliver approximately 5% growth in revenue and 11% to 12% growth in earnings over the coming 12 months.3 By region, the US is expected to deliver 16% earnings growth, emerging markets about 13%, Europe and Canada 8% to 9% each, and Japan about 2%.4
However, the strength of global growth and estimate revision data clearly moderated in the first quarter compared with the fourth quarter of 2017. In the US, consensus estimates have been bolstered by tax cuts and a weaker dollar, but in Europe and Japan, the strength of the euro and yen have acted as drag on exports and foreign earnings translation. More recently, the uncertainty around US trade policy has tempered the outlook for growth expectations globally.
In short, investors are less certain about 2018 growth today than they were three months ago and eagerly await first-quarter results to adjust expectations accordingly.
There has been no change in the overall picture of quality around the world: In general, non-US companies boast better relative balance sheet strength versus US companies, which are more leveraged.
If interest rates continue to rise from still low levels, we believe it will be only a matter of time before equity market investors begin to pay more attention to balance sheets and interest coverage ratios — critical components of our quality assessment. Even if rates do not rise, balance sheet strength will increasingly be in focus as changes to International Financial Reporting Standards disclosure (beginning Jan. 1, 2019) will require companies to include operating leases as part of their debt reporting, increasing leverage ratios and reducing return on assets in many instances.
There has also been no change to the stretched nature of absolute valuations, particularly in the US, where the Shiller price-to-earnings ratio and the price-to-book ratio have only been higher during the tech bubble of the late 1990s.5 On a relative basis, price-to-earnings and price-to-cash-flow ratios favor companies outside of the US where the relative earnings leverage story remains compelling, in our view.
While markets change, our EQV philosophy and process remain the same. All of the strategies managed by the team focus on identifying high-quality companies that have sustainable growth and are trading at attractive valuation levels. We believe recent volatility has brought renewed focus to the importance of these traits among investors.
Learn more about Invesco International Growth Fund.
1 Sources: FactSet Research Systems, MSCI
2 Based on first-quarter performance of the MSCI ACWI Growth Index versus the MSCI ACWI Value Index, the Russell 2000 Index versus the Russell 1000 Index, and the MSCI EAFE Small Cap Index versus the MSCI EAFE Index.
3 Sources: FactSet Research Systems, MSCI, as of April 8, 2018
4 Sources: FactSet Research Systems, MSCI, as of April 8, 2018. Based on the S&P 500 Index, MSCI Europe Index, MSCI Canada Index and MSCI Japan Index.
5 Sources: Yale University Department of Economics, FactSet Research Systems, as of March 31, 2018
Blog header image: Leigh Prather/Shutterstock.com
The MSCI All Country World Index (ACWI) is an unmanaged index considered representative of large- and mid-cap stocks across developed and emerging markets.
The MSCI All Country World Growth Index is an unmanaged index considered representative of large- and mid-cap growth stocks across developed and emerging markets.
The MSCI All Country World Value Index is an unmanaged index considered representative of large- and mid-cap value stocks across developed and emerging markets.
The MSCI Canada Index measures the performance of the large- and mid-cap segments of the Canadian market.
The MSCI EAFE Index is an unmanaged index considered representative of stocks of Europe, Australasia and the Far East.
The MSCI EAFE Small Cap Index is an unmanaged index considered representative of small-cap stocks of Europe, Australasia and the Far East.
The MSCI Emerging Markets Index is an unmanaged index considered representative of stocks of developing countries.
The MSCI Europe Index is an unmanaged index considered representative of European stocks. The index is computed using the net return, which withholds applicable taxes for non-resident investors.
The MSCI Japan Index measures the performance of the large- and mid-cap segments of the Japanese market.
The Russell 1000® Index, a trademark/service mark of the Frank Russell Co.®, is an unmanaged index considered representative of large-cap stocks.
The Russell 2000® Index, a trademark/service mark of the Frank Russell Co.®, is an unmanaged index considered representative of small-cap stocks.
The S&P 500® Index is an unmanaged index considered representative of the US stock market.
Gearing measures how much of a company’s operations are funded through debt versus equity capital.
The Shiller price-to-earnings (P/E) ratio, also known as the cyclically adjusted P/E ratio, is a valuation measure calculated using real per-share earnings over a 10-year period.
Price-to-book (P/B) ratio is calculated by dividing the market price of a stock by the book value per share.
Price-to-cash-flow ratio is a stock’s capitalization divided by its cash for the fiscal year.
Invesco International Growth Fund Risks:
Derivatives may be more volatile and less liquid than traditional investments and are subject to market, interest rate, credit, leverage, counterparty and management risks. An investment in a derivative could lose more than the cash amount invested.
The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.
Growth stocks tend to be more sensitive to changes in their earnings and can be more volatile.
Stocks of medium-sized companies tend to be more vulnerable to adverse developments, may be more volatile, and may be illiquid or restricted as to resale.
The Fund is subject to certain other risks. Please see the current prospectus for more information regarding the risks associated with an investment in the Fund.
Matthew Dennis, CFA
Senior Portfolio Manager
Matthew Dennis is a Senior Portfolio Manager with the Invesco International and Global Growth team, focusing on large- and mid-cap equities in Europe, Canada, the Middle East and Africa. Mr. Dennis is the lead portfolio manager on the Invesco Global Growth strategy and a co-manager of the Invesco International Growth and Invesco European Growth strategies.
Mr. Dennis joined Invesco in 2000 as a senior equities analyst on the International and Global Growth team and was promoted to portfolio manager in 2003. He assumed his current role in 2011. Prior to joining Invesco, he spent six years as a London-based equity strategist. Mr. Dennis served as a European and global equity strategist with ABN AMRO from 1996 to 2000. He began his investment management career in 1994 as an analyst on the equity strategy desk at Hoare Govett Securities.
A native of Houston, Texas, Mr. Dennis earned a BA degree in economics from The University of Texas at Austin and an MS degree in finance from Texas A&M University. He is a CFA charterholder.