International Equities At (Or Near) An Inflection Point

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Includes: ACWF, ACWI, AIIQ, DGT, DTEC, ESGF, ESGW, FIHD, FLQG, GLQ, HDMV, VGFO, VT, WBIL, XMX
by: Kevin Mahn
Summary

As trade negotiations progress is reported, as we saw recently between U.S. and Mexico, we would expect constrained stock prices across the globe to begin to rise accordingly.

Valuations, global economic growth forecasts and accommodative international central bank policies, all provide upside possibilities for international stocks.

There are still many potential risks and uncertainties as it relates to international equities that may continue to provide volatility inducing headwinds.

Selectively including international equities with U.S. equities in a global equities portfolio strategy, where appropriate, seems worthy of consideration.

I continue to believe that threats of potentially prolonged trade wars have served as an emergency brake to a stock market that has been pressing on the gas pedal to try and move forward with a growing global economy serving as a tailwind. As progress is reported with respect to trade negotiations, as we saw recently between the U.S. and Mexico, we would anticipate this emergency brake to be gradually lifted and for constrained stock prices across the globe to begin to rise accordingly. To this end, international equities seem particularly compelling right now as they have lagged U.S. equities thus far in 2018, despite their out-performance in 2017, and appear to us to be at (or near) an inflection point. Valuations, global economic growth forecasts and accommodative international central bank policies all provide upside possibilities for international stocks in our view. To better understand my viewpoint, I examine each of these driving factors below.

Valuations

When assessing the global equities market, we generally review the following representative benchmark indexes:

S&P 500 Index – The Standard and Poor's (S&P) 500 Index is a float-adjusted market capitalization index, composed of 500 widely held common stocks, which is generally considered as being representative of the U.S. stock market.

MSCI EAFE Index - The MSCI EAFE Index is a free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the U.S. and Canada.

MSCI EM (Emerging Markets) Index - The MSCI EM (Emerging Markets) Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets.

Looking at these representative benchmark indexes, international equities outperformed U.S. equities in 2017. This has not been the case thus far in 2018, and essentially has not been the case for the last 10 years as U.S. equities have been in a decade long cycle of outperformance.

Index (Coverage) 2018
Year-to-Date Return
2017
Calendar Year Return
1 Year
Annualized Return
3 Years
Annualized Return
5 YearsAnnualized Return 10 YearsAnnualized Return
S&P 500 Index
(U.S. Stocks)
3.43% 21.83% 16.24% 12.52% 13.12% 10.67%
MSCI EAFE Net Index (International Developed Market Stocks) -0.36% 25.03% 6.40% 5.03% 5.86% 3.43%
MSCI EM Emerging Markets Net Index (International Emerging Market Stocks) -4.61% 37.28% 4.36% 8.94% 5.25% 2.87%

Please note: Data sourced from Wells Fargo Advisors/Morningstar as of 6/30/18. Index performance is total return performance which includes gains and losses plus income unless otherwise noted. You cannot invest directly in an index. Past performance is not an indication of future results.

According to a 2018 Insight report from Hartford Funds entitled, “A Reboot for International Equities”, as they researched 5-year rolling returns since the mid 1970s, Hartford observed multiple periods of U.S. outperformance, followed by periods of international outperformance and then returning to U.S. outperformance again. The average cycle run was 7.3 years. Seeing as we are now more than 7.3 years into this cycle of U.S. outperformance, perhaps a shift in the outperformance pendulum is due from a statistical standpoint.

Furthermore, looking at current valuation indicators, international equities, across developed markets and emerging markets, appear more attractive relative to U.S. equities. For these purposes, I used both the Current Price to Earnings (P/E) Ratio and the Forward Price to Earnings (P/E) Ratio as current valuation indicators.

Index (Coverage) Current P/E Forward P/E Historical P/E (10 Year)
S&P 500 Index
(U.S. Stocks)
20.71 17.69 17.63
MSCI EAFE Net Index (International Developed Market Stocks) 15.47 14.20 20.31
MSCI EM Emerging Markets Net Index (International Emerging Market Stocks) 12.91 12.06 14.76

Please note: Data sourced from Bloomberg as of August, 23 2018. Current P/E is the ratio of a stock and the company's earnings per share and is calculated as the stock's price divided by trailing twelve month earnings per share (EPS). Forward P/E is calculated by dividing the price of a security by Bloomberg estimates of earnings per shares, looking at consensus estimates for the next four quarters. You cannot invest directly in an index. Past performance is not an indication of future results.

Global Economic Growth Forecasts

Economic growth, as measured by gross domestic product ("GDP"), has been robust in the U.S. thus far in 2018. This may be beneficial for international equities looking ahead as international economic cycles have typically lagged U.S. economic cycles by 1 – 3 years according to a Buffalo Funds research report published in August 2018 entitled, “The Case for Investing Internationally.” Additionally, according to this same report, GDP is actually growing faster in certain regions outside the U.S. and is projected to continue to outpace U.S. growth.

Central Bank Policies

In the U.S., the Federal Reserve has embarked upon a gradual and extended period of tightening that will continue to involve some combination of interest rate hikes and balance sheet reductions. With respect to interest rate hikes, as it stands now, I believe that the Fed will likely raise the Federal Funds Target Rate one more time this year and three additional times in 2019 as they address potential mounting inflationary concerns. This stands in contrast to many other central banks across the globe who will likely continue to pursue their own accommodative monetary policies by either maintaining current interest rate levels or perhaps even cutting their respective interest rates. This type of accommodative environment often helps to spur economic growth, which historically has been beneficial to upside stock price potential.

With these driving factors understood, there are still many potential risks and uncertainties as it relates to international equities that may continue to provide volatility inducing headwinds. These risks and uncertainties include, but are not limited to, on-going trade agreement tensions (Ex. U.S. and China), unrest in certain Emerging Market countries (such as Turkey and Venezuela) and fluctuating currency exchange rates. Despite these uncertainties, we, at Hennion & Walsh, see attractive investment opportunities for international equities looking ahead. While we could certainly also make a bullish case for U.S. equities over the short-intermediate term, selectively including international equities with U.S. equities in a global equities portfolio strategy, where appropriate, seems worthy of consideration.

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Disclosure: Hennion & Walsh Asset Management currently has allocations within its managed money program and Hennion & Walsh currently has allocations within certain SmartTrust® Unit Investment Trusts (UITs) consistent with several of the portfolio management ideas for consideration cited above.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.