May Be Time to Consider International Equities
By: David I. Templeton, CFA, Principal & Chief Investment Officer
Author: David I. Templeton ,CFA, Principal and Portfolio Manager
For nearly fifteen years international equities as measured by the iShares MSCI All Country World Index ex U.S. (ACWX) have underperformed the U.S. market, or S&P 500 Index, by a substantial margin. The green line on the below chart represents the performance of the S&P 500 Index and the index is up over 426% since late 2011 while the MSCI All Country World Index ex US is up only 122%.
As noted in a recent article (PDF) by Hartford Funds, since 1975 the outperformance cycle for U.S. stocks versus international stocks has occurred over approximately an eight-year cycle. The current cycle has U.S. stocks outperforming international stocks for almost fourteen years, six years longer than the average cycle.
An important variable for investors to consider when investing internationally is the strength or weakness of one's home currency. For a U.S. investor, a strengthening dollar serves as a headwind for international returns as more of the foreign currency is needed to convert back to a Dollar, thus reducing the US Dollar equivalent return. The green line in the below chart from Brandes Investment Partners represents the U.S. Dollar. A rising line signifies a strengthening Dollar. The dark or green circles on the chart represent the low point for the Dollar before it resumes its move higher or strengthens. The green circles coincide with the green shading for the return columns comparing the return of the MSCI USA Index versus the MSCI EAFE Index (Developed International.) The grey circles highlight the peak in the Dollar before the line trends lower or the Dollar weakens. The grey circles coincide with the grey column headings and in a weakening Dollar environment, international returns benefit from the weakening Dollar.
Currency moves are difficult to predict, but looking at the recent move in the U.S. Dollar it does appear to have reached some resistance from a technical perspective, i.e., making lower highs as noted by the downward sloping red dotted line on the below chart. The green dotted line represents support and if the Dollar breaks below that, further weakening could take place; thus, serving as a tailwind for international returns.
In reviewing weekly mutual fund and ETF flows, investors are not embracing the potential investment opportunity in international markets. Over the course of the last twelve months, the cumulative flow to global equites is a negative -$27.3 billion while U.S. equity inflows have totaled $218.8 billion.
Certainly, equity returns outside of the U.S. have been mostly challenging over the last number of years as noted earlier. The below year to date return chart is a short one, not yet two months, however, the three international indexes shown on the chart are all outperforming the S&P 500 Index. One area of the U.S. market that has been a tailwind for investors is the mega cap Magnificent 7 stocks. A lot has been written about the market over the last two years and the fact returns have been driven by a narrow group of stocks., i.e., strength in the Mag 7 stocks, but year to date the MAGS ETF is up 2.1% and trails the S&P 500 Index's year to date return. For investors, there might be an opportunity for some international exposure in one's portfolio, keeping in mind multinational U.S. companies have exposure in the international markets too. Also, higher interest rates tend to translate into a stronger Dollar, all else being equal, and recent commentary by the Fed suggests they will be more hawkish on rates.
The international environment faces some headwinds, not the least of which is the continued war in Ukraine and tariff issues proposed by the U.S. If some of these issues are resolved favorably though, international equities might find some support or better returns ahead. Since the international versus U.S. outperformance tends to run in a long multi-year cycle, an investor being late versus early to increase international exposure certainly would be reasonable. Nonetheless, the international asset class is one investors might want to keep on their radar.
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