International Equity Strategy Commentary

International equities continued to rise in Q3 propelled by a more accommodative Federal Reserve and excitement over AI adoption and the enormous capex by related companies boosting market earnings. The EAFE index rose 5.38% in local currency terms and 4.77% in US dollars as the Loonie depreciated against the euro. Financials was the best performing sector up 8.48% driven higher by continued gains in the banks which benefit from rising European and Japanese long bond yields. Consumer staples was the weakest sector down 0.96% – the group has suffered weaker volume trends and pricing amid concerns that weight-loss drugs are impacting food and beverage consumption.
Global six-month real narrow money momentum – a key leading indicator in our approach – moved sideways in August, following a March-July fall. We continue to expect the recent decline to be reflected in a loss of economic momentum from late 2025. The next slowdown could prove to be more serious than others in recent years because 1) the stockbuilding and housing cycles are in time windows to begin downswings and 2) labour markets are weakening, raising the possibility of self-reinforcing negative dynamics.

Political concerns have risen again in France where prime minister Sebastien Lecornu has resigned, unable to agree a budget in a fractious parliament. Fiscal concerns have pushed yields on French bonds above those of Italy for the first time since the Euro was launched in 1999 and French equities have underperformed other European markets year to date. Balancing the budget is also an issue in the UK where long bond yields have risen meaning taxes will rise again in November’s Budget.

In Asia, the Japanese ruling party Liberal Democratic party has unexpectedly chosen its first female leader Sanae Takaichi, whose Abe-style economic policies suggest a return to lower interest rates, higher defence spending and more pro-business reforms. However, the immediate policy requirement is to get inflation down from levels that are proving unacceptably high for voters, leaving the government lagging in opinion polls.

In China, the stock market narrative has shifted from ‘uninvestable to irresistible’ as stocks have recovered to the point where the government has attempted to cool investor euphoria. The rally has been fuelled by an AI-driven re-rating, as it becomes increasingly clear that the gap between US and China in foundation AI models is narrowing rapidly. Chinese firms are arguably making this progress at a fraction of the cost of the US hyperscalers, with one critical advantage being access to ultra cheap power channelled through a well-constructed grid.

Stock selection was the main negative detracting value across all regions and most sectors. Our quality/growth bias underperformed the value factor again as asset light, recurring revenue business models were hit by perceived AI disruption concerns. Stock selection was weak in IT where the underweight in Dutch semiconductor equipment manufacturer ASML (+25%) and overweights in German software companies SAP (-10%) and Nemetschek (-8%) detracted value. ASML earnings estimates were falling as orders from two out of three key customers have been softening; however, news that the US government was investing in chip maker Intel triggered a significant rally in September. Stock selection was also weak in materials where Sika (-16%) fell after downgrading its full-year guidance. The company now expects only modest sales growth and is experiencing increasing competitive pressures.

In industrials, UK-listed publisher Relx (-9%) is an example of a high-quality business with the perceived risk of AI disruption in its legal information division and concerns about the number of seats at its clients. Management disagrees seeing AI as an opportunity to utilise data better to raise prices, with its proprietary data set acting as a competitive moat. In financials London Stock Exchange (-19%) has also suffered from AI disruption concerns and again management believes these concerns are misplaced as half their data is real time and they also see opportunities to sell more. Elsewhere in financials our preference for insurance against a small underweight in banks was negative although not owning expensive, low growth Australian banks such as CBA (-5%) was positive. Illustrating trends within the sector, holdings such as Caixabank (+24%) in Spain, Mitsubishi UFJ (+22%) in Japan and Kbc (+18%) listed in Belgium all outperformed insurance stocks on the portfolio such as Axa (-1%) in France and Hannover Re (-2%) in Germany.

In healthcare, Japanese electro-optics specialist Hoya (+19%) is benefiting from an HDD shortage and is rising prices for its products, with demand for its glass substrates increasing as data centre investment accelerates. Stock selection was positive in staples where food manufacturers Danone (+9%) in France and Ajinomoto in Japan both gained in a weak sector, the latter benefiting from increased semiconductor spending on its microfilm known as ABF.

Activity over the quarter has added to materials with the purchase of mining companies Rio Tinto and Anglo American. Both stocks provide exposure to the copper market which will benefit from AI infrastructure build and recent supply disruptions. We have also added UK-listed engineer Weir Group after a constructive meeting with management highlighting its high proportion of recurring revenue from aftermarket sales. In Japan we have introduced Rakuten Bank replacing Fanuc after a confusing meeting with the latter’s CFO. We have taken profits in conglomerate Softbank and added semiconductor maker Screen Holdings which appears good value and is growing through increased demand for wafer cleaning machines as technology advances. We have also bought East Japan Railway which is about to unlock value from its Tokyo-based property portfolio while benefiting from the first rail fare increase in decades.

Active managers with a quality growth bias have found the recent market environment challenging as value stocks such as banks, utilities and telecom have performed well. Also, the differentials within sectors have been substantial; for example within industrials, aerospace and defence are up 89% year to date versus professional services (typically asset light, high return on invested capital companies) down 1.2%. Recent research suggests that the move to passive and quant investing is accentuating the influence of momentum as a driver of stock prices, reflected in increasing concentration and valuation dispersion, particularly in the US. Our process focuses on buying strong companies that achieve high returns and have room to grow organically. These companies should be the long-term winners. We are reminded of the Charlie Munger quote, ‘The big money is not in the buying and selling … but in the waiting.’

Our current focus is on AI beneficiaries including stocks with exposure to data centre build-out, power generation and copper demand. We are also playing the fiscal stimulus theme in Europe especially Germany, while also favouring stocks likely to benefit from falling bond yields as inflation returns to pre-covid levels. We are maintaining exposure to data vendors and software providers believing AI disruption fears are unproven. International markets should outperform an expensive US where there are signs valuations are vulnerable especially if you believe, as we do, that the risks economically remain to the downside. Quality stocks have suffered one of their longest periods of underperformance over the last 50 years but historically the recovery back to the long-term uptrend usually occurred quickly after the price relative bottomed.

The Composite rose by 0.62% (0.46% Net) versus a 4.77% rise for the benchmark.