We Asked T. Rowe Price's $17B International Manager Why Value is Winning Again — and What the S&P 500 Leaves Out

Colin McQueen · T. Rowe PriceBullish

Samsung's earnings are surging on AI memory demand; if forecasts hold, its price-to-book falls toward 1.2.

Samsung was a very big holding for the fund. Eighteen months earlier it traded at about 1x book value, the trough level at the worst point. It now trades just under 3x book. McQueen argues the stock is still attractive because, if consensus forecasts are right, earnings growth brings the multiple back to about 1.2x book in the next couple of years. He says the company is 'literally printing money' because AI demand for memory has tightened a market that previously had excess capacity.

“Today, it would be just under three [times book]. But, again, if you believe the forecast, it comes down to about 1.2 in the next couple of years because it is literally printing money.”at 19:51

Colin McQueen · T. Rowe PriceBullish

Alibaba is a rare competitive AI tech stack, bought at about 14x earnings.

The manager argues that China is probably the only other competitive tech stack for AI in the world. Investors can buy companies like Alibaba at about 14 times earnings, which the manager sees as an attractive entry point. This makes China's AI exposure worth holding in a portfolio at this stage.

“you're probably getting the only other competitive tech stack for AI in the world, and you're buying it at sort of 14 times earnings for companies like Alibaba.”at 48:32

Colin McQueen · T. Rowe Price

Japanese companies are releasing cash and real estate and targeting higher returns, a tailwind for value.

For years, value investors in Japan found companies with large cash balances and real estate holdings. The discounts never closed. McQueen says that is changing as companies release those assets, target higher returns on equity, and increase investor payouts. This asset-release and restructuring trend, particularly in Japan, has become a significant tailwind for international value.

“We're seeing companies kind of releasing those assets, starting to target higher returns on equity, investor payouts.”at 18:21

Colin McQueen · T. Rowe Price

International stocks are cheaper than US stocks in most industries, so the valuation gap is real.

The US-international price-to-earnings and price-to-book gap sits around the 25th percentile of its history, so international has usually been cheaper. Industry by industry, developed international is cheaper than the US in 9 of 11 industries, and in 11 of 11 once emerging markets are included. Tech is the exception, where US tech looks slightly cheaper. Adjusting for the US's higher tech weight closes about half the PE gap, though McQueen is not sure that adjustment is correct. The gap also reflects differences in interest-rate and restructuring dynamics.

“international is cheaper in nine out of 11 industries.”at 31:41

Colin McQueen · T. Rowe Price

International earnings growth has risen sharply since 2019, closing much of the gap with US earnings.

In 2010-2019, the EFA universe grew earnings about 1% a year versus 8% for the S&P 500, and international value about 0.5%. From 2019 to today, US earnings still grow about 8% a year, but international has risen to about 4.5%. That is not up to US levels, but the gap has closed materially. McQueen attributes this to the interest-rate backdrop and a better outlook for tangible-goods companies, which are heavily weighted in international indices. He thinks part of the valuation gap should have closed for this reason.

“Overall as an average, but international has kind of risen to about four and a half percent per annum.”at 33:36

Colin McQueen · T. Rowe Price

Japan's governance overhaul is re-rating companies; large caps priced in, so favour mid and small caps.

Japan's governance change is real and broad. The Tokyo Stock Exchange requires companies trading below book value to publish plans to maximise shareholder value, and societal pressure means nearly all companies now do so. Japan is also exiting 20 years of deflation, so companies are selling idle real estate and cross-shareholdings and targeting return on equity. The example is Hitachi: a conglomerate on about 8x earnings a decade ago that set its first 8% return-on-capital target, then disposed of weak businesses and reinvested in strong ones, reaching mid-teens returns and margins. The re-rating has released value, especially in low-end companies trading far below book. Because the market already prices the large caps, the fund has moved underweight Japan and sees more opportunity in mid and small caps and in other Asian markets copying the reforms.

“[Japan has had] a significant change in kinda how companies are managed and what they target.”at 41:23

Colin McQueen · T. Rowe Price

Korea's value-up reforms are working; 70% of KOSPI trades below book at 5x PE.

Korea was long unloved and cheap, partly because of conglomerate governance and an at-times capricious government towards foreign investors. The government's 'value up' programme is now legislating change: boards have fiduciary duties to shareholders for the first time, tax changes favour dividends, and many companies have raised payouts and return-on-equity targets. Reform is not complete, since inheritance tax reform is needed to unwind cross-shareholdings. Even after the run-up in Samsung and SK Hynix, 70% of the KOSPI still trades below book value. Many other companies sit at 0.6-0.7x book, earn 15-16% return on equity and trade on about 5x earnings. Korea is the fund's largest Asia ex-Japan exposure, where it buys world-beating companies at 5-6x earnings with strong balance sheets.

“70% of the KOSPI index is still trading below book value, and that's despite the run up its head.”at 46:15

Colin McQueen · T. Rowe Price

Moving from negative and zero rates to positive rates is a much healthier environment for banks in Europe and Japan.

Low and negative interest rates hurt financial business models, which were not designed for them. McQueen says rates had a very dramatic effect on financials in international markets. European banks with negative rates and Japanese banks with zero rates struggled, and a move to positive rates is much healthier for them. This dynamic helped drive the financials rally in Europe and is starting to show up in Japan.

“banks with negative interest rates in Europe, banks with zero interest rates in Japan, as you go into positive,”at 13:14

Colin McQueen · T. Rowe Price

European banks' excess capital returns could yield about 7-8% a year; still undervalued.

European banks no longer trade at half book, but their return on equity has risen from the negative-rate era to an average of about 14%, and most are pushing for higher. Excess capital has built up on balance sheets and is now being returned to shareholders. Taking the sector average, projections for the next few years imply a combined dividend and buyback return of about 7-7.5% to 8% a year. The manager sees a lot of undervaluation and scope for better capital usage. After a decade of regulators raising capital requirements and saying no, that is starting to reverse.

“The average is sort of about 14 in Europe, and most of the companies are pushing for higher than that. We've seen a lot of excess capital build up on balance sheets, and that's starting to be returned to investors.”at 50:22

Colin McQueen · T. Rowe Price

Around 14-15% of international stocks sit in the AI supply chain, including transformer and electrical suppliers doing well.

About 14-15% of international market stocks are connected to the AI supply chain. Some are direct tech plays. Others are industrial companies supplying transformers and electrical equipment, which McQueen says are doing very well. Those industrial suppliers are where the fund has found opportunities, especially in parts of Asia and Korea. The international exposure to AI is smaller than in the US but not zero.

“electrical goods, etcetera, are doing sort of very well out of these things.”at 19:24

Colin McQueen · T. Rowe Price

Unlike dot-com growth leaders, AI growth is capital-intensive and cannot fund itself from cash flow.

In the dot-com era, a cohort of fast-growing stocks threw off large amounts of cash and funded its own growth, which is historically rare. McQueen argues AI growth differs by nature. It requires continual investment: you do not build it once and leverage it many times over, you keep building more data centers and GPUs. He therefore sees the AI cycle as a different kind of capital story from the earlier tech boom.

“AI growth is, I guess, by its nature, more capital intensive.”at 23:08

Colin McQueen · T. Rowe Price

Inflation is probably not going back to zero, which changes discount rates and levels the field for value.

The world moved from a deflationary, near-zero-rate regime to an inflationary one through COVID and the Ukraine war. McQueen says inflation probably will not return to zero. This shifts the discount-rate dynamic that had hurt value, so value is no longer fighting with one hand behind its back. He describes this as leveling the playing field rather than tilting it toward value, and sees it as a durable change.

“We can all get out our crystal balls and try and argue exactly where inflation is gonna go, but it's probably not going back to zero.”at 12:51

Colin McQueen · T. Rowe Price

Tangible-goods companies have a better, more durable growth path as capex on grids, defense and AI accelerates.

McQueen sees a long list of tangible spending needs after COVID: infrastructure, localised supply chains, energy transition, grid buildout, defense rearmament after the peace dividend reversed, and AI. Suppliers to that spending are having a much better time, with margins improving and order books at record highs. He thinks this is more durable than the consumer-goods demand that tends to drive the rest of the economy. Industrial and commodity-linked companies benefit most.

“So, yeah, I think it gives them a better, more durable growth path.”at 15:57

Colin McQueen · T. Rowe Price

Rising bond yields are turning former bond-proxy compounders into a headwind for the stocks that benefited from falling yields.

Steady, intangible-heavy compounders behaved as bond proxies. They did well while bond yields kept falling because their future cash flows were valued at lower discount rates. McQueen argues that yields are now rising, which removes that tailwind and adds a headwind for these stocks. Higher yields also raise what investors need to be paid to own low-growth stocks.

“You know, they behaved as bond proxies, and that was great when bond yields were only going down, but I guess now bond yields are going up.”at 16:37

Colin McQueen · T. Rowe Price

AI demand moved memory and passive components from excess capacity to undersupply, giving suppliers pricing power.

Memory and passive components have historically been commodity businesses that supply PCs and mobile phones, and the suppliers sat with excess capacity. A wave of AI demand pushed these markets into undersupply. That gave suppliers pricing power, and their share prices went from hated to loved very quickly. McQueen cites this as a source of profitable international opportunities.

“And suddenly this wave of demand came out of AI and moved that into undersupply.”at 20:24

Colin McQueen · T. Rowe Price

Incumbents holding proprietary customer data may defend better against AI disruption than startup attackers.

McQueen thinks AI works well with lots of data. Many incumbents hold large amounts of customer data that a startup attacker cannot access. He suspects this shifts the balance between incumbent and disruptor, especially in regulated financials. He is not fully sure of the point, and says the market is still discovering which companies will benefit from AI and which will be disrupted.

“I'm not a 100% sure of this, but I kinda think AI works well with lots of data.”at 23:28

Colin McQueen · T. Rowe Price

Tech's share of the S&P 500 rising from about 20% to 40% concentrates investors in one industry's fate.

An investor who has owned the S&P 500 for a couple of decades has seen tech's weight rise from about 20% to about 40%. That has worked very well, but it has made the portfolio more and more exposed to one industry. McQueen argues that an international portfolio alongside it provides diversification, which matters more at a time of high valuations and uncertain end drivers.

“And that's worked really well, but it makes you more and more exposed to the fate of one industry.”at 32:39

Colin McQueen · T. Rowe Price

Italy, Spain and Greece have a better economic outlook than other European markets.

The Mediterranean economies were at the centre of the eurozone financial crisis. They have since gone through more adjustment, including resetting real wages and restructuring. As a result, Italy, Spain and Greece have been doing better than the European average, and their stock markets have performed better too. The manager says that five years ago it would have seemed unlikely that Italian banks would outperform the Magnificent Seven.

“we're seeing a bit of a better economic outlook in markets like sort of Italy, Spain, Greece than we necessarily have been in some of the other areas.”at 39:47

Colin McQueen · T. Rowe Price

Weak yen flatters Japanese exporters' earnings, but a sharp reversal could hit them hard.

The yen has been very weak, which is a large tailwind for Japanese exporters. The manager says they are not currency experts, but the yen is far from purchasing power parity. If it reverses, it could move sharply the other way. The fund therefore does not treat today's earnings and cash flows of Japanese companies as permanent. This caution is one of the reasons it has moved underweight Japan.

“The yen has been super weak, so that's a massive tailwind for the exporters in Japan... if it moves, it could move quite sharply the other way.”at 44:14

Colin McQueen · T. Rowe Price

China's domestic economy is weak, but cheap, competitive companies merit some portfolio exposure.

Chinese valuations have come down over time. The domestic economy is weak because of the property market, and there has been almost no post-COVID bounce. Even so, the manager finds dynamic companies with good technology, excellent cost competitiveness and improving product quality. Some Chinese competitors are taking market share while trading cheaper than Western counterparts. Governance and legal structures are hard to navigate, and tax changes can be hard to anticipate, so the fund approaches China with caution. It still feels right to hold some Chinese exposure in a portfolio because the stocks are cheap.

“it feels to me as as part of a portfolio, you wanna have some exposures to China, and you're getting cheap companies.”at 48:24

Colin McQueen · T. Rowe Price

A US recession would materially hurt the rest of the world; markets won't decouple.

The US is still a large economy, so a recession there would have a material impact on the rest of the world. Global markets are still largely international, with a lot of international and US money investing around the world, so they remain linked. Trade interconnections have pulled back a little, but the manager does not see the decoupling as a whole.

“The US remains a pretty important country economically speaking. So if the US goes into recession, it's gonna have a material impact on the rest of the world economy. So I don't think we decouple in that sense.”at 52:36

Colin McQueen · T. Rowe Price

ETF and index flows move stocks in baskets, creating mispricings for fundamental investors.

Many investors now buy ETFs and futures indices rather than individual stocks. Stocks therefore move in baskets, tied to their country or a theme. Something can be oversold because it is grouped with a basket that is falling. Fundamental investors can exploit this by moving against the broad trend and buying cash flow cheaply.

“a lot of times these days, it's people buying ETFs. It's people buying futures indices... we see a lot of occasions where stocks move in baskets”at 54:28

Colin McQueen · T. Rowe Price

Europe lacks US-style tech innovation, partly because venture and scaling are weaker.

The manager is not an expert on the topic but gives several reasons. The European venture capital industry is less developed. Silicon Valley has become a cluster of expertise that acts as a magnet for talent and companies. It is also harder to scale a product across Europe than across US states, because of more barriers. The gap is most visible in IT. Industrial innovation and pharmaceuticals are more balanced.

“I'm not an expert in this sort of topic... There's probably been a part in Europe also that it's harder to scale across a European market, than it is across The US.”at 55:29