- International equities have long underperformed their US counterparts and could do so again.
- Michael Sheldon, Head of Investments at RDM Financial Group, explains how to spot a reversal.
- These seven indicators, in addition to a peaceful resolution of the Russian-Ukrainian war, are essential.
It’s one of Wall Street’s favorite traditions: predicting that this is the year that international equities finally beat their US counterparts.
But over the past nine years, excluding 2017, foreign stocks, as measured by the Vanguard Total International Stock
The ETF (VXUS) has lagged the S&P 500. Since 2013, Vanguard’s international ETF has returned 27.6%, much worse than the S&P 500’s 214.1% gain.
Buying low on international equities has not been a winning strategy for most of the past decade, and early indicators indicate that the S&P 500 will once again outperform its foreign peers, albeit slightly.
Stocks around the world have been reversed this year as investors worry about spikes in economic growth, soaring inflation and the Russian-Ukrainian war. The latter risk has hit particularly close to home for European equities, given the region’s reliance on Russian oil and coal.
This convergence of concerns means it’s not yet time to dive into international equities, but that could soon change, said Michael Sheldon, chief investment officer at RDM Financial Group, in a recent interview with Insider. RDM Financial Group, a financial advisory firm based in Westport, Connecticut, primarily serves high net worth clients with assets of $2-5 million.
“The U.S. economy is generally doing better than many other parts of the world, but at some point overseas markets will start to do better,” Sheldon told Insider. “And you have to consider – if you don’t have any foreign exposure – you’ll probably have to consider adding foreign exposure at some point.”
Although long unloved, international equities are still not ready to shine
Sheldon’s bull case for international equities hinges on their attractive and cheap valuations, solid dividend payouts and the potential to be a solid alternative to domestic equities if the United States slips into a
. Sheldon said an economic slowdown was not his base case, but he expects weaker domestic growth.
Furthermore, this first point is probably the most compelling: Vanguard’s international ETF has price-earnings, -book and -sales ratios of 13.4, 1.7 and 1.2 which are dwarfed by that of the SPDR S&P 500 ETF Trust (SPY), which point to 26.5, 4.4 and 2.96 respectively.
“Overseas markets are more attractive on a valuation basis, and dividend yields are higher, and business cycles behave differently overseas than here in the United States,” Sheldon said. “So there are reasons to have some exposure overseas: to increase diversification and hopefully improve your investment returns.”
Sheldon continued: “But I think it’s a little early at this point, given what’s going on – particularly in Ukraine and Russia – to be too excited about Europe or overseas markets at the moment. .”
7 changes needed for a recovery in foreign equities
To say it’s too early to pounce on foreign equities begs the question: when will that change and how will investors know it’s time to rebalance their portfolios?
The precise timing is impossible to know, but Sheldon said his firm has begun to balance its clients’ portfolios over the past six to 12 months away from the US and growth stocks they had long been overweight and toward value and international names. .
Investors hoping to take advantage of the long-awaited rally in foreign equities should keep an eye out for seven signs, Sheldon said: the US dollar strengtha risky environment, monetary and fiscal policiesand trends for job, manufacturing, consumer spendingand company profit. Monitor everything instead of grabbing a single indicator, he said.
Currency movements can be confusing to less experienced investors, but they are essential in determining whether domestic or international stocks are outperforming. When the US Dollar Index (DXY) rises and strengthens against the Euro, meaning a dollar is worth more Euros, US stocks tend to outperform. The reverse is true, as a weaker dollar pushes foreign stocks higher.
“Historically, at least, when the dollar depreciates or goes down, it’s been a tailwind for American investors investing overseas,” Sheldon said. “In recent months, the dollar has actually strengthened because US Fed policy has tightened and interest rates here in the US are rising sharply.”
As Sheldon noted, the rising dollar is one reason foreign stocks may not rebound anytime soon.
International equities also tend to fare better when investors are more comfortable with the global economic backdrop. US stocks are considered a safe haven and tend to outperform in times of crisis, such as at the start of the pandemic and during the Russian-Ukrainian war.
“When there’s a riskier environment in the world, people feel more willing to invest outside of US security,” Sheldon said.
A resolution of the Russian-Ukrainian war and a convincing decline in inflation would boost investor sentiment globally and therefore likely benefit international equities disproportionately.
Monitoring the last five trends mentioned by Sheldon in all the key countries outside of the United States may seem like a herculean task, but investors can probably get a solid understanding of what’s going on by staying locked into what’s happening in two economies. reviews: Europe and China.
In Europe, as in the United States, inflation has reached multi-decade highs, but monetary policy is still ultra-loose. Interest rates in the euro zone, as set by the European Central Bank (ECB), are in the cellar at 0%, and officials have said they will not raise rates until the end of its program purchase of bonds. UBS expects asset purchases to continue through early fall, Mark Haefele – the firm’s chief investment officer – wrote in an April 8 note, adding that the first hike could take place in December.
More difficult news for members of the European Union is that the bloc’s unemployment rate is still well above that of the United States at 6.2%, manufacturing data weakens again after a strong rebound and consumer spending is still below pre-pandemic levels.
But it’s not all bad news for Europe: Reuters reported in late February that Goldman Sachs had called for European earnings growth of 6% per year until 2024, the same rate as in the United States. . Matching or exceeding earnings growth in the United States could spur a rally in European equities.
Meanwhile, China is infamous for its corporate-unfriendly policies because its authoritarian government punishes companies that grow too powerful because it sees them as a threat. However, the advantage of having a seemingly all-powerful government is that it can – in theory – flip a switch and stop the knife-dropping that Chinese stocks have been for about a year.
China’s central bank pledged in late March to better support the economy and financial markets, Bloomberg reported. It also flooded the markets with liquidity in December as its housing market continued to falter.
Investors are keeping their fingers crossed that these policies will pull the Chinese economy out of the recession it finds itself in. The country’s unemployment rate fell to 5.5% from 4.9% in October, manufacturing data has eased, consumer spending has grown steadily in recent years but could be weighed down by lackluster consumer confidence , and private sector profits fell 1.7% at the start of 2022, according to FX Empire. All of this caused problems for Chinese equities.
If the headwinds in Europe and China become headwinds, international equities will likely take over from their US counterparts. But investors may not want to hold their breath until that happens.