Carl M. Kawaja
Equity Portfolio Manager
Carl Kawaja is an equity portfolio manager and principal investment officer of American Funds EuroPacific Growth Fund®, the world’s largest actively managed international equity fund. In this interview, Carl explains why he is optimistic about international stocks following a long period of trailing U.S. markets.
Q: What is your outlook for international equity markets?
A: It’s been a very strong year so far for non-U.S. markets and I expect that to continue. Prior to the start of 2017, international equities went through a difficult period, lagging U.S. equities for nearly a decade. In the EuroPacific Growth Fund, we provide international diversification because we believe it’s a prudent part of an overall investment portfolio, but the results also need to be competitive relative to the S&P 500 over some significant period of time. There will always be periods when international stocks lag, but there also should be times when they outpace U.S. markets and I believe we are embarking on one of those periods now.
Q: Why do you think the rally will continue into 2018?
A: There are quite a few reasons. Non-U.S. companies are starting to put a greater emphasis on profitability and shareholder returns. We’re seeing broad-based strength across a number of international markets, not just one or two. We’re also seeing strength across all sectors. The European economy has stabilized. Japan appears to be headed in the right direction. And many emerging markets are as strong as they’ve been in quite a while. Dollar weakness has also helped. Additionally, Europe and Japan took longer than the U.S. to recover from the global financial crisis so, arguably, they have more room to run. For all of these reasons, I remain positive about the outlook going forward.
Q: Do you feel less optimistic about U.S. stocks?
A: In the U.S., I am less sanguine, but I’m also not particularly negative either. U.S. equity valuations have gone up a lot over the past couple years, however, we’ve also seen a tremendous earnings recovery and we’ve seen remarkable innovation at a variety of companies. So, yes, I am more confident about the outlook for non-U.S. markets, in part, because U.S. markets have been very strong. But amid all the gnashing of teeth and hand wringing about high valuations in the U.S., I think a lot of folks have lost sight of the incredible innovation, discovery and progress that’s been made in the U.S. over the past decade — particularly in the information technology, consumer discretionary and health care sectors. That drives asset values. I think investors would be well served to keep a core allocation to U.S. equities, but think about rebalancing toward international markets.
Q: Some would argue that global equity market gains in recent years have been largely driven by central bank stimulus measures. What’s your view?
A: The world’s major central banks have provided a favorable tailwind, without a doubt. But would financial markets or certain companies be doing well today absent those stimulus measures? Yes, certainly. I think there’s no question about that. Did quantitative easing and low interest rates help Google a little bit? Maybe. But many other things helped, too. Google is at the forefront of developing self-driving car technology. Google acquired YouTube and now roughly 40% of all music consumed in America is consumed on YouTube. I use Gmail every day. I use Google search every day. This is a company, in my opinion, that would have done well over the past few years with or without central bank interventions in the financial markets.
Q: What about political risk in Europe? Are you concerned about the spread of populism and nationalism, especially as the U.K. prepares to leave the European Union?
A: I have a slightly non-consensus view with respect to European integration. On balance, I think it has succeeded. We have a common currency that was established despite great teething pains. In recent years, it would have been easy for Italy to waive its debts and go back to the lira, but the Italians decided it was not in their best interest. The same with Portugal and Spain. For some countries, the rewards have accrued asymmetrically. Spain had a period where European integration was the best thing possible. Spaniards were borrowing money at German interest rates, and building new homes, and that created a lot of wealth. And European integration has certainly been wonderful for Germany. It’s the biggest economy in Europe, so if you want to argue that Europe has not been successful, you’d have to leave out the biggest place.
Q: Shifting to emerging markets, Chinese internet companies have been among the best-returning stocks in 2017. What’s driving their success?
A: That’s a regulatory question. China doesn’t allow U.S. internet companies to operate in the country. Although I’m generally not a fan of government intervention, it seems to have aided China in developing their own internet companies. China’s internet companies are not poor shadows of their U.S. counterparts; they are quite innovative and progressive themselves. For example, Alibaba is a world-class e-commerce company. That doesn’t mean it would be successful in the U.S., but Alibaba’s service offering is extraordinary and certainly comparable to Amazon’s service in the West. Meanwhile, in Europe, we’ve seen the exact opposite. U.S. internet companies have colonized Europe. The Facebook of France is called Facebook. The Twitter of Germany is called Twitter. The Google of Spain is called Google.
Q: Japan has suffered through decades of economic stagnation, but there are signs of recovery in the works. How do you think about Japan from an investment perspective?
A: Japan has been a wonderful place to invest over the years, largely because we have ignored the economic conditions and focused on individual companies with great products. A good example is Nintendo, which has a popular video game console called the Switch that’s both portable and stationary. It's a traditional game console and you can also take it with you while you're walking around. A product like that has nothing to do with the Japanese economy, or central bank policies, or the political leadership of the country. Nintendo has a game console and video games that people love. This is why we focus on fundamental, bottom-up research.
Q: Tell us about the investment approach of the EuroPacific Growth Fund. How is it positioned and how are you thinking about the future?
A: In terms of how EUPAC is positioned, the fund is differentiated from its benchmark (the MSCI All Country World Index ex USA) because it reflects the highest-conviction ideas of our team of portfolio managers and analysts. For instance, we’ve had a degree of concentration in Chinese internet companies. We’ve had a lot of exposure to the technology sector, and we’ve had some success in emerging markets, which have generally fared well this year. Also, I would add that EUPAC is the largest actively managed international-focused mutual fund, but our size has not inhibited our results. In relative terms, as well as absolute terms, we have done well against our benchmark even as the size of the fund has grown.
I’ve been involved with this fund for more than 20 years and I will say one of our advantages is — although it is called growth fund — it’s actually a very flexible fund. We focus on growth of capital, not necessarily growth companies. So that means we can buy companies with low valuations if we think they are going to be re-rated and the share price is going to rise. Our portfolio managers have the flexibility to take different approaches, depending on each specific opportunity. Our primary goal is to do well for our shareholders on a long-term basis and to avoid terrible down periods to the greatest extent that we can. For me, that has led to an approach that says: be flexible.
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