Investing During a Global Crisis
09/29/2008 12:00 am EST
Allan Nichols, editor of Morningstar InternationalInvestor, identifies the pitfalls and opportunities in global market today.
Q. Allan, how can investors protect themselves should the financial crisis in the US result in prolonged bear markets around the world?
A. Studies have shown the majority of returns from the stock market have been concentrated over a relatively few days, so it is important to have some exposure. My experience, though, has shown bear markets last longer than you think. Asset allocation is particularly important and I would increase cash from my bond allocation rather than from my stocks. Now is the time to buy really high-quality stocks at attractive prices, those that have sustainable advantages, or what Morningstar calls “moats.”
Morningstar borrowed the concept of a moat from Warren Buffett. Just as a moat around a castle protected the castle from invaders, a company's moat protects the firm from competition. Moats can be generated from being the low-cost producer; having intangible assets, such as patents or other unique intellectual property; and high switching costs that make it uneconomical to change to another product or service. All of these improve a firm's ability to compete as well as earn returns above its cost of capital.
Q. What are the biggest risks for global investors now?
A. One of the biggest risks to prolonged weakness is the European Central Bank. President Jean-Claude Trichet continues to refuse to cut interest rates and seems more interested in proving the bank is independent than he is about recessions in European countries or the global economy. While inflation is running above targets, it is clear growth is slowing, which will decrease inflation.
Q. Are there any pockets in Western Europe that will be better than others, in the near term?
A. Scandinavia and Switzerland will hold up better. Both are smaller countries with strong savings rates, have their own currencies, and headquarter some strong companies. While Switzerland includes UBS (NYSE: UBS) and Credit Suisse (NYSE: CS), which have both been caught up in the credit mess, it also holds Novartis (NYSE: NVS), a leader in pharmaceuticals.
Finland has Nokia (NYSE: NOK). The press has doted on Apple's (NASDAQ: AAPL) iPhone, but Nokia still has the largest share of smart phones and its distribution of low-end phones in emerging markets—where most of the new subscriber growth is generated—is unparalleled. ABB (NYSE: ABB) is a Swedish-Swiss mix that is a leader in boosting efficiencies in factories, increasingly important when margins are being squeezed.
Q. Emerging markets have had big sell offs this year. Would you still encourage investors to actively participate in them?
A. Earlier in the year, emerging markets held up remarkably but recently, money has fled, crushing many of them. But their economies will continue to grow faster than developed markets and an investor should have exposure to them.
Q. Morningstar’s price/fair-value ratios have substantially dropped for many stocks around the world. What does this mean for investors?
A. Our fair value estimates—the analyst's estimate of the worth of a stock—are generated by a proprietary discounted cash flow model, which includes analyst expectations. The biggest drivers are revenue growth, margins, and capital expenditures. A price/fair value ratio of one says the stock is trading at its fair value; above one means overvalued, and below one is undervalued.
As of September 15th, the median ratio for all international stocks we cover was 0.75, meaning the median stock was trading at a 25% discount. This is the lowest reading since I began calculating the ratio two and a half years ago, which shows the market is relatively cheap.
Q. Which are your favorite companies right now?
A. I'm interested in more defensive plays in industries that generate significant cash flow and that are fairly resistant to the state of the economy. Novartis (NYSE: NVS) has a strong pipeline for branded drugs, the second largest generic business in the world, and a strong vaccine and consumer businesses. This diversification reduces volatility in its earnings from any particular business.
And France Telecom (NYSE: FTE) generates strong cash flow from its incumbent fixed-line businesses in France and Poland, which it is reinvesting in wireless and broadband. These businesses are providing some growth, particularly its continued expansion into Africa and other emerging markets.