In the February Commentary, we noted that international equities had underperformed U.S. equities and were due for a rebound. The strong performance of the MSCI EAFE Index relative to the S&P 500 Index in late May through early June and the latest weakness in the US dollar are noteworthy. International developed equities are mostly composed of European companies. There are now some good reasons to be cautious.
1) Weaker economic outlook: Bloomberg’s consensus forecasts expect European economies to contract more than those of the United States or Japan in 2020 due to the pandemic. Although Europe has generally done as well or better than the United States in containing the virus, the economic impact of the lockdowns appears to be greater there, and its stimulus jolt has lagged that of the United States and Japan. Bloomberg’s consensus estimate for Eurozone gross domestic product (GDP) contraction in 2020 is 8%, down from growth of 1.3% at the start of March. US GDP forecasts have fallen a bit less during this time—from 1.8% to -5.7%.
2) International markets are more value oriented: Until more signs of a durable economic recovery emerge globally, value stocks will be challenged to sustain a relative performance advantage over growth stocks. The MSCI EAFE Index for non-US developed market equities has only 8% in the technology sector, compared with 26% in the S&P 500. Internet retail and digital media exposures—well positioned for the pandemic—are also much lower in the MSCI EAFE Index and create a relative performance headwind when these groups lead, as they have recently.
3) Performance continues to disappoint: International equities have been unable to sustain relative outperformance compared with the United States for much of the past 10 years. Until the MSCI EAFE Index can sustain strength for more than just a month here or there, caution is warranted.
4) Valuations are not good short-term timing tools: International stocks have not received much help from low valuations in recent years. Valuations generally do not tell us much about the next year or two, so there is no immediate reason re-allocate from US equities to international. Lower valuations, however, have correlated well with long-term returns, suggesting strategic investors who are in it for the long haul may benefit from an allocation to international developed markets.
5) Structural concerns: Post-crisis, deficits, and populism may continue to weigh on investor sentiment, consumer spending, and capital investment for the Eurozone. There has been a recent movement toward a coordinated fiscal response to COVID-19, but once this crisis passes, more coordination will be needed to drive better returns across Europe.
There are, however, several paths for upside for international developed equities.
1) Coordinated global growth recovery: Once the virus is well contained, we may see global equity market correlations increase. Europe is a big exporter to China—although there are tensions there, too—and the United States would benefit from a strong global recovery. In a global recovery, value stocks could keep pace with or possibly outpace growth stocks, helping international equities.
2) Japan could surprise: Bloomberg’s consensus forecast for Japan’s GDP contraction in 2020 is -4.9%, less of a decline than in Europe or the United States. In fact, the latest policy proposal could bring Japan’s fiscal policy boost to 40% of its GDP, more than double what the United States will likely end up with, even after the next potential package. Japan has also done a good job containing the virus in general. It remains to be seen, however, if these stimulus packages boost the underlying economies or just the markets.
3) Further US dollar weakness: Typically, trade and budget deficits in the United States put downward pressure on the US dollar, which may prop up international investment returns. The Bloomberg US Dollar Index has fallen 6% since the S&P 500 bottomed on March 23 and the safe-haven trade began to reverse.
Opportunities in the US market appear more attractive than developed international over the next 12 to 18 months. To get more interested in developed international markets, there should be more evidence of a durable global economic recovery and increased investor demand for value stocks.
The views expressed are provided for information only and are not to be used or considered as an offer or solicitation to buy or sell securities or investment products. To determine which investment(s) may be appropriate for you consult your financial advisor.
- The economic forecast set forth in this presentation may not develop as predicted, and there can be no guarantee that strategies promoted will be successful.
- Data provided by LPL Financial, Bespoke Investment Group, Factset.
- All investing involves risk including loss of principal.
- All indices are unmanaged and cannot be invested into directly.