The PACER PERSPECTIVE
February 2023

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Sailing Abroad:
Identifying International Value Investing Opportunities

- Danke Wang, Portfolio Manager

Most investors admit they don’t have enough international exposure in their portfolios. However, many believe there may be a significant opportunity in the international space going forward.

Key takeaways:

• US equities’ outperformance compared to international stocks over the past 15 years does not justify continuing to overweight US stocks in the future.
• With headwinds facing US equities, international markets may offer better growth, valuation, and income-potential.
• A recent strong US dollar has contributed negatively to international investing. A weaker dollar could reverse the currency impact and favor investing globally.
• High free cash flow yielding stocks in the international space provide a unique opportunity because of their high income-potential and cheap valuation.¹

International vs. Domestic Stocks Historically
The table below shows the equity allocation of US stocks relative to international stocks among investors of different age groups. On average, US investors still allocate more than 80% of their equity holdings to the US stocks.

⁽¹⁾Free cash flow yield (free cash flow/enterprise value) is an internal statistic and does not constitute investor yield.

PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS. YOU CANNOT INVEST IN AN INDEX
https://www.personalcapital.com/blog/investing-markets/average-portfolio-mix-by-investor-age/ July 6, 2021

This overconcentration of US equities is sometimes explained as home country bias or the tendency of equity investors to favor domestic stocks over stocks based in foreign countries.

Since the financial crisis in 2008, US equities have outperformed international stocks by a large margin. Such outperformance almost justifies investors’ focus on the US market. Because if you haven’t allocated most of your money to US stocks over the past 10+ years, you may be lagging behind your peers who have.

However, looking at the past 20 years of stock market performance by country, the US is not even in the top 10.

PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS. YOU CANNOT INVEST IN AN INDEX Source(s): Source: https://novelinvestor.com/historical-returns/

Historically, the relative performance of US versus international equities has been cyclical. Those cycle duration's range from as short as 1.5 years to 15 years, with the latter being the most recent US outperforming cycle. However, historically the average cycle lasts about five years.

PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS. YOU CANNOT INVEST IN AN INDEX Source: Bloomberg, Pacer Advisors

In the past 15 years, the S&P 500 has had an annualized return of 8.8%. The higher relative strength of US stocks can be explained by a relatively strong economy, low interest rates, and leadership in high-growth companies.

Now, after the Fed’s most aggressive rate hikes in 2022 and with the long-duration growth companies facing headwinds, people may be wondering if this is the beginning of a new cycle. Notably, US corporations are vulnerable to earnings downgrades in 2023 (we have seen more downside revisions since Q2 2022), indicating that US equities are still expensive.

Are The Tides Changing?
While it is almost impossible to predict the exact timing of a trend reversal, certain features make international markets more appealing.

Specifically, international equities have more attractive valuations based on dividends, earnings, and free cash flow (FCF).

As of 1/31/2023, international equities are trading at close to the largest discount to the US since the early 2000s. International equities offer more than a 1.5% yield premium relative to the US, highlighting that income-seeking investors may want to search for yield abroad.

Though we have seen some early signs of US equity earnings weakness, international equity earnings are showing greater potential. Particularly China’s reopening, the peak of the Fed’s rate policy, and a potential weak dollar may support higher growth in the emerging markets.

As we emerge from the pandemic, the cyclical tailwinds for international equities and support from valuations could fuel a period of international outperformance ahead (though we can't predict future performance).

PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS. YOU CANNOT INVEST IN AN INDEX
Chart Source(s): FactSet
 

Source: Bloomberg, Pacer Advisors

The Dollar’s Impact on International Investing
One of the major concerns of investing in international stocks is currency risk, or the risk from the change in price of one currency in relation to another. A strong dollar in 2021 and 2022 has resulted in a negative currency impact on a global portfolio.

The chart below shows the yearly currency impact (US Dollar return minus Local currency return) when investing in a portfolio tracking the MSCI ACWI ex-US index. The returns introduced by the currency fluctuation are not necessarily negative all the time. When the USD was weakening, the currency translation actually boosted the investment return by more than 5% a year.

Source: Bloomberg

After appreciating for two years, the US dollar has turned lower in Q4 2022 as the Fed’s hiking cycle slowed. When international growth starts to pick up, further downside pressure could exist on the dollar, which might provide a tailwind for international investing.

Source: Bloomberg

The Dollar’s Impact on International Investing
Despite the widening valuation between the US and international markets mentioned earlier, what’s even more striking is how inexpensive FCF-oriented value stocks outside the US have become.

Pacer Global Cash Cows Dividend ETF (GCOW), Pacer Developed Market International Cash Cows 100 ETF (ICOW), and Pacer Emerging Market Cash Cows 100 ETF (ECOW) portfolios offer high free cash flow yield (double-digit for ICOW and ECOW), P/E multiples less than 7, and dividend yields greater than 5%.

Chart Source(s): FactSet. Dividends are not guaranteed

Though US equities have outperformed international stocks for the last 15 years, tides have started to change for the investment case in the developed and emerging international markets.

GCOW, ICOW, and ECOW search for quality and value in developed and emerging international markets by screening for companies with high free cash flow yields and dividend yield (extra screen in GCOW strategy). The funds seek to offer attractive valuations and income-potential.

For investors interested in diversifying outside the US, risk mitigation in the form of valuations and income may be the way to go in the current environment.

PACER CASH COWS INDEX ETF SERIES, INTERNATIONAL SELECTION:
Pacer Global Cash Cows Dividend ETF (GCOW), Pacer Developed Market International Cash Cows 100 ETF (ICOW), and Pacer Emerging Market Cash Cows 100 ETF (ECOW)

This document does not take into account any investor’s particular investment objectives, strategies, tax status, or investment horizon. Please consult with your financial advisor and tax advisor before investing.

This document is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. This document represents an assessment of the market environment at a specific time and is not intended to be a forecast of future events or a guarantee of future results. The user of this information assumes the entire risk of any use made of the information provided herein. There is no guarantee this strategy will be successful.

Free Cash Flow (FCF): A company’s cash flow from operations minus capital expenditures (expenses, interest, taxes, and long-term investments)
Free Cash Flow Yield: FCF/EV. Measures a company’s total free cash flow relative to its enterprise value. This is an internal statistic and does not constitute investor yield.
P/E: price-to-earnings ratio is the ratio for valuing a company that measures its current share price relative to its earnings per share (EPS).
Forward P/E: Forward price-to-earnings is a version of the ratio of price-to-earnings (P/E) that uses forecasted earnings for the P/E calculation.
Dividend Yield: The dividend yield is a financial ratio (dividend/price) that shows how much a company pays out in dividends each year relative to its stock price. Dividends are not guaranteed.
S&P Developed Ex-U.S. BMI: The index is a member of the S&P Global BMI series, and captures all companies from developed markets excluding the United States.
S&P BMI Emerging Market Index: The index is a member of the S&P Global BMI series, and captures all companies domiciled in the emerging markets within the S&P Global BMI with a float-adjusted market capitalization of at least USD 100 million meeting 6- and 12-month median value traded requirements.
S&P 500 Index: The index includes 500 leading companies and covers approximately 80% of available market capitalization.
FTSE All World Eurozone Index: The index comprises large and mid cap stocks in Eurozone markets. The index is part of FTSE All-World Index.
FTSE UK Index: The index comprises large and mid cap stocks in United Kingdom. The index is part of FTSE All-World Index.
FTSE Japan Index: The index comprises large and mid cap stocks in Japan. The index is part of FTSE All-World Index.
FTSE All World EM (Emerging Market) Index: The index comprises large and mid cap stocks in emerging market. The index is part of FTSE All-World Index.
FTSE China Index: The index comprises large and mid cap stocks in China. The index is part of FTSE All-World Index.
MSCI USA Index: The index is designed to measure the performance of the large and mid cap segments of the US market.
MSCI EAFE Index: The index captures large and mid cap representation across 21 Developed Markets countries around the world, excluding the US and Canada.
MSCI ACWI ex-US Index: The index captures large and mid cap representation across Developed Markets (DM) countries (excluding the US) and Emerging Markets (EM) countries. The index covers approximately 85% of the global equity opportunity set outside the US.

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