2011 Analysis: “Look for underappreciated stocks… and growth stories”

By: William Bower, Fidelity Investments, Manager Fidelity Diversified International Fund.

Looking at Europe and Japan, developed market economies have some very similar problems to those we are seeing in the United States: slow recovery and slow job growth. While the United States seems to be aggressively trying to restructure its banking system, Europe, in particular, has struggled to produce a concerted response. I think the outlook for developed markets at the moment is challenging.

Globally, the only place that seems to have had meaningful growth recently has been the emerging markets. Brazil, China, and India have shown their mettle despite the broad slowdown in developed market economies. Their domestic economies have grown large enough that they've been able to grow on their own rather than rely solely on exports. It used to be that when the United States slowed down, emerging markets got crushed. That's just not the case anymore.

But there is no free lunch here. You have to look at the valuations. If you want to own growth in emerging markets, you're going to have to pay for it. I wouldn’t say it’s a crowded trade, but the merits at this point are well known.

From a top-down view, I think the outlook for the United States is marginally better than for other developed nations, but they all face very similar problems. And the emerging markets are a place where you can get growth, but you have to consider the valuations very carefully.

Follow the growth

The valuations are cheapest in those parts of the world where you have the greatest problems-the developed countries. So, if Europe and the United States really improve, if job growth kicks in and the developed world recovers, that's probably a better place to be in terms of investments. On the other hand, if we limp along and have a pedestrian recovery, investors probably want to have some exposure to emerging markets.

I don't know how the recovery will unfold, so I have owned both. I think international investing is like casting a net; it's just a much bigger net.

Think energy, emerging market consumers, technology

There are a couple of long-term investment themes that I find appealing. One has to do with energy. Because oil is one of the few commodities in the world that tends to operate at high capacity utilization, there isn't a lot of excess in the supply chain. As emerging markets grow and develop, I think oil is going to get tighter.

China currently consumes about 13% of the world's oil. But when you look at other commodities, such as copper and iron ore, demand from China can be as high as 50% of the world’s total. I think oil may follow that trend. Over the next five to ten years, I believe oil consumption in China could double.

Emerging market demand doesn't just show up in commodities, however. Major consumer product companies have achieved 30% to 40% of their revenues from emerging markets, which is tempering slow growth in developed world markets. I am also interested in technology.

The bottom line

Relative to fixed income, stocks seem like a good position to me, especially if the global recovery is better than expected. When you look at the United States and Europe, I feel valuations are generally inexpensive, particularly when you think of other alternatives like bonds. But I think it’s possible to find attractive stocks in both the developed and the emerging markets. I look for underappreciated stocks and companies with compounding growth stories that will be really resilient in challenging economic environments.