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Debt ceiling: Investors brace for volatility as key votes loom

State Street Global Advisors Chief Investment Strategist Michael Arone joins Yahoo Finance Live to discuss opportunities for investors amid a potential debt ceiling deal, the value of the U.S. dollar, and international investments.

Video transcript

JULIE HYMAN: But I want to get to some other potential opportunities for investors. Michael Arone is still with us-- State Street Global Advisors chief investment strategist. As we talked about a little bit earlier, stuff like Nvidia is pricey. We might continue to see the overall AI universe go up. But in the break, we we're also talking about some areas maybe investors weren't paying as much attention to that might provide some opportunities right now. And you were saying maybe people should look outside the US.

MICHAEL ARONE: So I think that is something that we are talking to clients about and investors for the second half of the year. And so I think it's interesting. I think that international stocks like Europe and Japan have underperformed the US for a decade. And as a result, they are cheaper.

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But that's not enough of a reason to buy them. They're always cheaper. There's structural reasons why they're cheaper. I had a client joke with me. He says, every year, someone comes around in January with a British accent and tells me to buy Europe because it's cheap. And that's not a reason to buy.

So what are the reasons? Interestingly enough, there's two. There may be more than two, but there's two that stand out. The first is over the last three quarters of the earnings season, revenue growth and earnings per share growth and the magnitude of which those companies are beating in MSCI EFA stocks, for example, is far better than the US. So now, all of a sudden, that 30% discount that I'm getting on a price to earnings basis on a valuation basis becomes a lot more interesting.

And then the second component of this is that we expect the dollar will soften some as the Fed ends its tightening cycle. So naturally, it rises when the Fed's tightening rates. But when they stop, the dollar usually falls over.

Now, just quickly, last year, we know the UK shot itself in the foot. Japan's holding on tightly to yield curve control. Everyone was worried about Europe and the Ukraine-Russia war and the potential winter energy crisis, and, of course, the China issues in terms of common prosperity and zero COVID. All of those have started to come back a little bit.

And the dollar is down about 10% or so from its highs. So as a US-based investor, that acts as a tailwind. So I think it's the combination of those three things that makes international investing. And then, just quickly, Japan just hit a 33 year high I think just yesterday. So it continues to do quite well.

BRAD SMITH: Well, that's been one of Warren Buffett's favorite new entry points over the course of this year. I mean, last year, it was about oxy. This year seems to be more about where he sees some of the growth opportunities within Japan. Why do you think that is?

MICHAEL ARONE: Well, it doesn't surprise me as Warren Buffett as the value investor, right? There's a picture of him next to value investing maybe in the dictionary. Although, that probably ages me some, Brad. But I think the view here is that if I look at the-- and you just show the chart. The market, a lot of the NASDAQ stuff, hides a lot of the underlying narrowness. So it's only five or so companies that have really resulted in that 25% year to date gain. And the breadth in the market just hasn't been very good.

So if I think about this just quickly, not to be too wonky, but if the S&P is trading at 19 times forward earnings, and I take the inverse of that, the earnings yields about 5%. Well, you, Julie, and I can buy a money market fund right now that yields 5%. So why take the equity risk?

But international stocks like Japan trade at 10 or 11 times their earnings. So the earnings yield on that is closer to 9%. And therefore, there's a bit of a cushion. And value investors like that cushion. So it doesn't surprise me that Warren Buffett sees that as a value opportunity given some of the valuation dynamics from US stocks to international.

JULIE HYMAN: Now, all of the international stuff you've been talking about thus far is developed markets. It's not emerging markets. Are emerging markets then less attractive?

MICHAEL ARONE: So we're more neutral in our positioning right now in emerging markets. Now, we were underweight so we're more neutral to our benchmark-- about a 10% allocation to the equity. That's about what their weight is in the global benchmarks.

So the challenge, Julie, is that they should benefit from lower inflation. They should benefit from a weaker dollar. And they should benefit from the fact that the Fed is likely to end, whether it's in June or kind of this summer, they're likely to end their tightening cycle soon.

So that's all a benefit. The challenge is that their earnings and revenue growth just hasn't been as good. The estimates have been falling. And therefore, the same kind of valuation dynamics just aren't as attractive right now. Keeping a close eye on it.

BRAD SMITH: Michael Arone, State Street Global Advisors chief investment strategist, has been joining us throughout the morning. Thanks so much, Michael. We appreciate it.

MICHAEL ARONE: Thank you.