Source: Bloomberg
Two years ago, we shared a message with clients highlighting the upside potential of international stocks within diversified portfolios (International Stocks… No Longer Your Portfolio’s Wallflowers). In that piece, we gently pushed back against investor skepticism and apathy toward the value of international exposure. While we acknowledged the chronic underperformance of international markets over the previous decade and a half, we argued that abandoning geographic diversification didn’t make sense. In fact, we saw intriguing opportunities amid the widespread “meh” sentiment, such as in Japan’s stock market. Since then, Japanese banks have surged nearly 90%.
However, it’s important to acknowledge that, overall, international stocks have continued to underperform U.S. equities. Last year, the ACWX Index (which tracks the largest stocks outside the U.S.) was up just 2%, compared to the S&P 500’s 24% gain. Despite this, there are still signs of potential, with two geographic regions standing out in terms of outperformance: Europe and China.
In Europe, the German stock index is near all-time highs, and the Euro Stoxx 50 is close behind. These indices are being buoyed by potential fiscal stimulus in Germany (following the recent election), and the possibility of de-escalation in the Russia/Ukraine conflict. A reduction in tensions could ease pressure on oil and gas prices, providing a disinflationary boost to the broader European economy. Moreover, speculation is growing that increased defense spending across Europe could serve as an additional economic stimulus.
China’s struggling economic situation has served as a “wet blanket” over the global economy for some time now. Its primary challenge has been to find a balance between allowing the ailing property sector to recover while also stimulating broader consumer demand. There have been some recent positive signs, demonstrated in a 10% increase in the Hong Kong index year-to-date, and Chinese policy actions that indicate support of measures aimed at boosting demand, which could help revive both the economy and markets.
But what about the threat of new tariffs from the U.S.? Importantly, it’s still early in the new administration with the complete scope and impact of its policies remaining unclear. However, reshaping global trade, particularly with China and Europe, is likely to remain a key focus for the next four years. In fact, international stock indices sold off after the election, driven by fears of this shift in trade becoming a reality. That said, we think part of the strength of international stocks this year may be attributed to the market reassessing the potential impact of an extreme tariff approach. The administration is signaling that many tariffs could be gradual and reciprocal, targeting specific industries. This more nuanced approach may allow the market to reprice certain global sectors without triggering systemic worries. However, this doesn’t mean tariffs will be absent as a factor going forward. Indeed, if the administration is serious about reducing the deficit, backing away from its stated posture on aggressive use of tariffs is unlikely.
Finally, use of the term “American Exceptionalism” is prevalent in investor conversations. This refers to a bias toward U.S. assets – such as taking an overweight position in large U.S. tech companies – with the belief that investing globally is unnecessary. While enacting a U.S. bias strategy has clearly paid off for quite some time (the last decade, at least), and we’re certainly not suggesting that large-cap U.S. tech companies are poor investments, we also see opportunity in global investments. If the trend of “American Exceptionalism” pauses—due to factors such as high stock valuations or a recalibration of AI spending—capital may flow into other asset classes that currently have lower valuations and are emerging from a downtrend, particularly international stocks. Today, we’re expressing this view by investing in internationally focused ETFs and selecting stocks of companies headquartered outside the U.S., including those in Europe and both developed and emerging markets in Asia.