Investing Beyond Borders: The Case for Developed Markets Abroad

Thematic Research Analyst Zachary Navarro explains how the theme demonstrates Chevy Chase Trust’s ability to uncover overlooked investment opportunities.

Could you provide an overview of the ‘Opportunities Abound Abroad’ theme?

This theme reflects our conviction that developed markets outside the United States — particularly in Europe and Japan — are likely to exceed expectations. While U.S. markets have led global returns for more than a decade, changing geopolitics as well as structural reforms in fiscal, energy and industrial policies are taking hold in Europe and Japan. These changes, combined with more attractive valuations, could drive stronger equity performance abroad and present compelling opportunities for long-term investors.

Can you provide more details on the developments driving these changes?

In Japan, the Tokyo Stock Exchange (TSE) has introduced regulatory changes that encourage mergers and acquisitions, as well as greater returns to shareholders, through dividends and buybacks. Further, inflation has picked up modestly, allowing the Bank of Japan to implement positive interest rates for the first time in nearly a decade. In Europe, post-Sovereign Debt Crisis reforms have made banking systems more resilient, while strengthened cooperation amongst EU Member States is breaking down internal barriers. Furthermore, significant shifts in fiscal policy are allowing for more debt to support higher levels of spending on infrastructure, research and development and defense. These structural changes improve the investability of those markets.

What prompted Chevy Chase Trust to research this area?

The genesis of this theme was a valuation discrepancy that we began tracking some time ago. U.S. stocks were trading at historically high multiples — far above their 10-year averages — while non-U.S. developed market multiples were in line with or even below their historical valuations. We began to question whether the valuation discrepancies were warranted going forward, given the structural changes we were beginning to see in Japan and Europe. The disconnect between market perception and economic reality — paired with the U.S. vs. non-U.S. valuation gap — became too compelling to ignore.

Can you walk us through the process of creating a new theme, using Opportunities Abound Abroad as an example?

This theme began with our macroeconomic research process. Each week, we review extensive data and analysis — everything from economic indicators to geopolitical developments. When we see a shift happening, we dig deeper to assess whether it’s investable. In this case, we started with an observation — that U.S. valuations were high compared to other developed markets — and sought to understand why this was and what might change. During our work, we identified desirable structural changes underway in certain developed markets outside the U.S. that convinced us that the past valuation differences between the U.S. and non-U.S. markets weren’t likely to persist longer term. From there, we identified specific companies that stood to benefit from those changes. Once we determined the opportunity was large enough to represent a meaningful portion of the portfolio, it became a formal theme — one that we announced in the second quarter of 2023. 

How does this theme reflect Chevy Chase Trust’s Global Thematic Investing approach?

This is a textbook example of our process. We start with technological, scientific, demographic or macroeconomic shifts — in this case, the changing dynamics in Japan and Europe — and work through the implications for companies and industries. We don’t just respond to headlines. We conduct extensive, proprietary, in-depth research, assessing long-term viability and asking whether there’s enough breadth and depth to build a diversified theme consisting of investment opportunities across different sectors and regions. If there is, and the valuation case is strong, we’re ready to invest.

How has this theme evolved in the past two years? Where do you see it going in the future?

At first, we focused on the structural reforms happening in Europe and Japan. Over time, those reforms have accelerated — Germany has significantly shifted its stance on debt, NATO countries are boosting defense spending, and trade barriers within the EU have continued to fall. In Japan, mergers and acquisitions are at all-time highs with returns to shareholders climbing as Japanese companies change their attitude on buybacks and dividends. Meanwhile, U.S. valuations have risen even higher above historical averages. Going forward, we anticipate the valuation gap could narrow through some combination of international valuations improving and/or U.S. valuations contracting. Valuations abroad should rise as investors appreciate the changes made by the TSE to make Japanese firms more attractive, or as European economies benefit from common debt issuance, more fiscal stimulus and the reduction of internal barriers. Meanwhile, U.S. valuations may be reduced as investors consider the long-term profitability of artificial intelligence investments or the U.S. fiscal position.

How are current U.S. policies and economic uncertainty impacting this theme today?

Some of the more protectionist policies we’ve seen recently in the U.S. are adding friction to global trade — but they’re not reversing globalization. Instead, they’re forcing supply chains to adapt. Goods that once came directly from China might now be routed through Vietnam or Indonesia to lower tariff rates. This reconfiguration creates inefficiencies and raises costs.

Further, U.S. tariffs should result in lower domestic import demand and may lead to global manufacturing overcapacity. In the near term, this overcapacity should result in lower prices in non-U.S. markets. Over a longer horizon, politicians may attempt to solve manufacturing overcapacity by either producing fewer goods or encouraging higher levels of consumption. We believe the former would likely result in a global recession while the latter would result in more balanced growth with a greater share generated in non-U.S. markets.

At the same time, rising deficits and spending constraints in the U.S. may limit economic growth and hamper innovation as government funded R&D is sacrificed due to the rising cost of servicing the national debt. In contrast, many developed markets abroad are breaking down trade barriers, embracing investment and fostering economic cooperation — all of which we believe bode well for this theme.

What questions are you hearing from clients about this theme?

Lately, the biggest question we get is whether the theme is already fully valued. The short answer is no. In fact, the valuation gap between U.S. and non-U.S. developed markets has widened even further in the past quarter. We track that data closely and see room for international markets to continue their recent outperformance. Overall, we believe the structural reforms and economic shifts underway are still in the early innings. As these fundamentals continue to take hold, we expect this theme to continue to play out.

Important Disclosures