International Equities Monthly
- Treading Water: After a sharp decline in the first half of the year, the U.S. dollar has leveled off. Its next move is uncertain, though the balance of drivers points to a downside bias.
- Relative Interest Rates: Softer U.S. labor data has raised expectations for more Fed rate cuts, while many trading partners’ central banks are on hold or leaning toward rate hikes. This makes U.S. assets less attractive to foreigners. Inflation also plays a role (real rates). Tariffs could push U.S. prices higher while putting downward pressure on global prices due to excess manufacturing capacity, further eroding the relative appeal of holding U.S. assets.
- Oil Prices: Since the U.S. became a net oil exporter, the dollar has become positively correlated with oil prices. Higher crude prices improve the U.S. terms of trade, while lower prices have the opposite effect. In other words, the demand for dollars rises and falls with the price of oil. With oil down ~10% year-to-date, slowing economic growth in the U.S. and China (the largest consumers of oil), and OPEC+ boosting supply, the backdrop looks unfavorable for the dollar.
- Fair Value: Purchasing power parity and other valuation measures suggest the dollar is richly valued. While valuation is a poor timing tool, persistent fiscal and current account deficits keep the U.S. reliant on steady foreign capital inflows to fund these deficits, an ongoing vulnerability.
- Productivity: Recent productivity gains may continue with AI adoption. This should be dollar positive.
- Sentiment: The dollar remains the world’s reserve currency and safe haven, but sanctions, tariffs, and U.S. policy unpredictability have nudged some foreign bodies toward gold and searching for other substitutes. Still, no credible alternative exists with the size and depth of our debt markets, making this more of a marginal drag.
- Summary: Taken together, the fundamentals point to longer-term vulnerability for the dollar, supporting the case for U.S.-based investors to have strategic allocations in international equities.
- We maintain a neutral strategic allocation to developed international equities.
- Traditional performance drags such as currency volatility and expanding valuation discounts are easing and may even become tailwinds. With these pressures abating, developed international equities are better positioned to compete with U.S. stocks, with earnings and dividends as the primary drivers of returns.
- By contrast, U.S. equities face several headwinds: stretched valuations, elevated profit margins, and the likelihood of continued slow economic growth, all pointing to more modest longer-term returns.
- Tariff agreements with Japan and Europe reduced near-term trade fears and were generally received positively by the markets, removing worst-case trade scenarios, at least for now. Nonetheless, both Japan and Europe still face trade headwinds with the U.S. and China.
- The fundamental backdrop remains mixed. Economic growth in the eurozone has slowed considerably, with business investment being the main drag on growth. And political risks are worth watching in Japan, the UK, and France. Still, global revenue exposure limits the impact of local politics on heavyweights that dominate the index for those countries. Europe’s economy is expected to gradually rebound, while Germany’s suspension of its debt brake opens the way to fiscal stimulus, and Japan continues to push for shareholder-friendly reforms.
- Looking forward, we believe a strategic allocation to developed international equities should benefit longer-term investors due to potential diversification benefits, lower valuations, a possible currency tailwind, and less reliance on a narrow set of U.S. stocks.
- We have a strategic weight in emerging market (EM) equities, reflecting a balanced risk/reward profile versus U.S. equities.
- As with international developed markets, currency and valuation headwinds are easing, meaning they are less likely to weigh on returns, they may even enhance returns. With these headwinds easing, we see dividends and earnings driving EM equity, putting them on more even footing with U.S. stock return drivers.
- Expected Fed rate cuts should support emerging markets as they give EM policymakers more room to stimulate growth and could boost capital flows. Historically, EM has outperformed both U.S. and developed international stocks during Fed easing cycles.
- EM also provides significant exposure to the technology sector (the largest EM index weight) and AI. The index includes key companies in the global AI semiconductor supply chain. And investors gain exposure to China’s differentiated approach to AI (open source), which may broaden the investable universe by spreading AI adoption more rapidly and widely.
- Looking ahead, we believe EM earnings appear well-positioned to rival U.S. earnings over the next decade, supported by favorable demographics and a more growth-oriented index composition. Valuations remain compelling, with broad discounts to the S&P 500 on earnings and book value (India being the main exception). Lower labor costs and less saturation in technology and services create room for future operating leverage.
- EM investing is not without risks. Tariffs are likely to remain a growth headwind while China’s economic growth is slowing. Heightened political uncertainty seen in several countries is also something of a constant for EM.
- In summary, EM equities should remain a strategic holding, offering diversification and long-term growth potential, despite ongoing risks.
Equity Indexes Characteristics
The Indexes mentioned are unmanaged statistical composites of stock market or bond market performance. Investing in an index is not possible.
Glossary of Investment Terms and Index Definitions
*Local currency earnings estimates are not available for broad indexes with a mix of currencies.
Source: Bloomberg. Percent ranks are based on 30 years of monthly data as of the end of July; EPS growth estimates based on consensus bottom-up analyst estimates.
The Touchstone Asset Allocation Committee
The Touchstone Asset Allocation Committee (TAAC) consisting of Crit Thomas, CFA, CAIA – Global Market Strategist, Erik M. Aarts, CIMA – Vice President and Senior Fixed Income Strategist, and Tim Paulin, CFA – Senior Vice President, Investment Research and Product Management, develops in-depth asset allocation guidance using established and evolving methodologies, inputs and analysis and communicates its methods, findings and guidance to stakeholders. TAAC uses different approaches in its development of Strategic Allocation and Tactical Allocation that are designed to add value for financial professionals and their clients. TAAC meets regularly to assess market conditions and conducts deep dive analyses on specific asset classes which are delivered via the Asset Allocation Summary document. Please contact your Touchstone representative or call 800.638.8194 for more information.
A Word About Risk
Investing in equities is subject to market volatility and loss. Investing in foreign and emerging markets securities carry the associated risks of economic and political instability, market liquidity, currency volatility and accounting standards that differ from those of U.S. markets and may offer less protection to investors. The risks associated with investing in foreign markets are magnified in emerging markets due to their smaller economies. Events in the U.S. and global financial markets, including actions taken to stimulate or stabilize economic growth may at times result in unusually high market volatility, which could negatively impact asset class performance. Banks and financial services companies could suffer losses if interest rates rise or economic conditions deteriorate.
Performance data quoted represents past performance, which is no guarantee of future results. The investment return and principal value of an investment in the Fund will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance may be higher or lower than performance data given. For performance information current to the most recent month-end, visit TouchstoneInvestments.com/mutual-funds.
Please consider the investment objectives, risks, charges and expenses of the fund carefully before investing. The prospectus and the summary prospectus contain this and other information about the Fund. To obtain a prospectus or a summary prospectus, contact your financial professional or download and/or request one on the resources section or call Touchstone at 800-638-8194. Please read the prospectus and/or summary prospectus carefully before investing.
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