Is 2023 the Year for International Equities?

Geopolitical shocks, energy prices and economic turmoil have challenged investors the world over. With high interest rates and inflation, the Canadian market is no exception to the instability. Elevated household debt largely caused by the housing market is one of the largest risks to Canada’s economy. Although Canadians amassed close to $4 trillion of net worth during the pandemic and ensuing real estate boom, over $900 billion was lost due to rising interest rates. It’s expected that $15 billion of household spending will be cut in 2023. To put equity valuations in perspective, they are relatively low while remaining 20% to 25% higher at the end of 2022 than they were during both the 2008 Global Financial Crisis and the start of the Covid-19 pandemic.

In the United States, while a recession has not hit yet, various factors suggest that a broad-based decline could occur in 2023. From the inverted yield curve, higher rates, tighter lending policies, job cuts, labour wage pressures, rising debt and longer-term inflation pressure, a recession and subsequent bull market are more than likely stateside. At a minimum, investors can expect more volatility in 2023.

With North American markets challenged, opportunities abroad may offer more optimism.

To be clear, Europe is also struggling with elevated inflation, which is above 10%. Soaring energy prices and the possibility of winter shortages have tamped down consumer and business confidence to a 10-year low. However, these downside risks already appear to be reflected in massively discounted EU valuations, which can create quite attractive entry points. Plus, there are several factors that may jumpstart Europe’s outlook, including a de-escalation of the war in Ukraine, lower natural gas prices and the reopening of China’s economy.

Growth prospects for Asia over the medium term appear to be at mid-single digit levels. While this is a far cry from the double-digit growth of more than a decade ago, loosening Covid-19 restrictions should be key to China’s recovery and that of global supply chains. Industries supporting China’s long-term development growth plan are still expected to dominate and be critical to global supply chains. Furthermore, the most recent AidData “Listening to Leaders (LTL)” Survey indicated that global leaders who worked with China were more optimistic about its progress in development and reforms.

Japan’s prospects for improvement in 2023 look even more optimistic.   With positive economic, monetary policy and inflation conditions and the lifting of travel restrictions, many companies are well positioned to grow profits in the coming year.  After decades of deflation, Japan might be going into a period of positive inflation resulting from upward pressure in energy prices and the weakening of the Yen.  Producers may pass these increases to end consumers, resulting in higher profitability.  The Bank of Japan also forecasts Japan’s real GDP will grow by 1.9% in 2023 and 1.5% in 2024, along with strong household earnings and a resilient labour force.

Globally, there are fewer than 20 semiconductor producers that can make chips at scale, with East Asia and China dominating the vast majority of related manufacturing and production assembly.  Semiconductors are the world’s most widely traded products after automotives and oil, and chip manufacturing poses immense barriers to entry with enormous capital requirements and technical complexities. The industry is controlled by a few major players in Taiwan, China and South Korea.  Investors can access this robust industry through single countries with heavy tech sector weightings that tap into the world’s top global chip producers (see Exhibit 1).

Despite decelerating global demand and tighter monetary policy, India is still set to be the second fastest growing economy in the G20 by 2023.  GDP growth is expected to slow down to 5.7% by 2024 as India’s exports and domestic growth slow down, however, improved global conditions are expected to boost growth to almost 7% by 2025.  Indian households are becoming the greatest spenders among G20 countries and are expected to continue to outpace average growth rates of real GDP and real GDP per capita from 2021-2030.  This assumes structural reforms, infrastructure and human capital investments, and labour market improvements.

Compared to Canada and the U.S., international equities look attractive from a valuation standpoint and offer greater upside potential. As of Oct 31, 2022, the U.S. and Canada’s cyclically adjusted P/E ratios (CAPE) were roughly 31 and 20, respectively. These are relatively rich when compared to other developed markets and, especially, emerging markets that are roughly 50% cheaper (see Exhibits 2 & 3 below).

These valuations represent an opportunity to rebalance after a memorably volatile year and to position portfolios for greater upside potential as reversion to the mean will eventually take place (see Exhibit 4).

With international equities looking more attractive, Franklin Templeton recently launched its most cost-effective ETFs that provide exposure to passive International Markets and Emerging Markets (see Exhibit 5):

• Franklin International Equity Index ETF (FLUR) tracks the Solactive Global Benchmark Series (GBS) Developed Markets ex North America Large & Mid Cap CAD Index NR
• Franklin Emerging Markets Equity Index ETF (FLEM) tracks the Solactive GBS Emerging Markets Large & Mid Cap CAD Index NR

At a time when international markets look more attractive, these ETF solutions can enable investors to obtain efficient passive exposure to both developed and emerging markets at the most cost-effective manner at 9 basis points (bps) and 15 bps, respectively.

For investors seeking more targeted international exposure, our suite of passive equity single-country and regional ETFs can help build precise international portfolios to allow tactical execution of global investment convictions and amplify existing strategic positioning in broad markets.

With the right ETFs, investors can make 2023 the year for capturing opportunities in international equities (see Exhibit 6).

Exhibit 6 – Franklin Templeton Canada Single Country and Regional ETFs