Markets & Finance

Foreign Exposure Should Pay Off


From Standard & Poor's Equity Research

It's been a cruel few months for international stocks, which had been the smart choice since the current bull run began in October 2002. These high-fliers slid south in May on fears that world central banks, through interest rate hikes intended to tamp down the potential for rising inflation, would stifle global growth in the second half of 2006. The usual Cassandras issued jeremiads against this latest manifestation of Tulipmania, claiming the good times were over, if not for good, then for a good long while, thus providing humbled market participants ample time to contemplate their sins against the principles of defensive investing.

The doom merchants are, in S&P's opinion, wrong again. What we've experienced is nothing more than a healthy return to reality. "Markets are just readjusting to the realization that both inflation and interest rates have bottomed and are now rising, albeit modestly and from historically low levels," says Alec Young, S&P global markets strategist. "But we believe that the current global correction has discounted these risks and that the equity risk-reward ratio in many developed and emerging markets is now favorable from a longer-term standpoint."

While Young cautions that volatility will likely persist through much of 2006, as markets readjust to the new macroeconomic realities, he sees longer-term opportunities emerging -- in particular, among mid-to-large-cap U.S. companies with broad exposure to consumers in developing markets.

A key theme going forward, Young says, is a gradual shift in consumption growth from the U.S. consumer, whose willingness to open the wallet has carried the rest of the world in recent years, toward emerging nations where per capita incomes are rising sharply. The macro headwinds of higher U.S. interest rates, a slowing housing market, a sharp drop in home equity refinancing, and higher energy costs make it increasingly unlikely that the U.S. consumer can continue to single-handedly fuel global growth.

Based on their impressive contribution to global growth, Young thinks developing markets like South Africa, India, China, Brazil, Mexico, Argentina, Russia, and Eastern Europe have burgeoning middle classes with rising disposable incomes. In addition, by his analysis, developing nation consumer penetration rates in otherwise mature product categories like cosmetics, autos, branded apparel, home appliances, packaged goods, leisure entertainment, and consumer electronics remain surprisingly low. For example, while churn may be high in the domestic cell phone business, customer growth is booming in India, where five million new wireless subscribers are added each month, according to The Economist.

"The business of America is business," Calvin Coolidge famously claimed, and nothing is so consumer-focused as the American corporation. Taking advantage of rising emerging market demand for gadgets that make life easier, more productive, and more fun is a natural fit for U.S. multinationals in search of faster sales growth, Young says. He notes that, although many leading U.S. multinationals have long histories in developing markets, they are only now reaching the scale necessary for these operations to have a meaningful positive impact on overall profit margins and earnings growth.

Four- or five-STARS stocks that we see benefiting from these trends are listed in the table below. Also, please note that the issues with Quality Rankings of A- or higher have the advantage of participating in another trend S&P has identified, namely, the rotation into high-quality stocks.

Global Plays


American Apparel's Future
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