International Equities Monthly
- The U.S. dollar has weakened notably in recent months, even as conventional supports, like widening interest rate differentials and newly imposed tariffs, would normally push it higher. This break from historical patterns suggests a deeper shift in investor
sentiment and macro fundamentals. - Part of the story is growth. Expectations for the U.S. economy are softening amid tighter credit conditions, a peaking labor market, and signs of consumer fatigue, which are contributing to U.S. growth concerns.
- Investors may also be responding to growing political uncertainty. The Trump administration's confrontational stance, particularly its willingness to use economic leverage unilaterally, has eroded trust in U.S. policy stability, diminishing the dollar’s traditional safehaven status.
- From a valuation perspective, the dollar looks vulnerable longer term. On a purchasing power parity (PPP) basis, it remains overvalued relative to many major currencies. The real trade-weighted dollar has also begun to turn lower, signaling a potential shift
toward a secular decline. - Twin deficits present additional pressure. The U.S. continues to run sizable current account and fiscal deficits, requiring steady foreign capital to sustain. If overseas demand weakens, the dollar could come under further strain.
- Foreign appetite for U.S. assets appears to be cooling, especially among large asset holders such as sovereign wealth funds and global central banks. While total foreign holdings remain high, recent growth has been driven more by the private sector.
- In short, while the dollar’s recent decline runs counter to some traditional macro drivers, shifting fundamentals and perceptions may be ushering in a new chapter for the greenback, supporting a strategic weight to international equities for U.S.-based investors
- We have increased our exposure to developed international equities to a strategic weight, reflecting a more balanced risk/reward profile relative to U.S. equities.
- We believe that traditional headwinds, such as currency volatility and valuation discounts, are unlikely to be significant performance drags and may even turn into tailwinds. When these factors are neutralized, international developed equities stand on more equal footing with their U.S. counterparts, with earnings and dividends driving returns.
- Meanwhile, U.S. equities face pressure from high valuations and the prospect of slower economic growth, suggesting more muted returns ahead.
- By contrast, the international landscape shows signs of improvement. Germany’s suspension of its debt brake opens the door to fiscal stimulus which could bolster growth, and Japan continues to push for more shareholder-friendly corporate behavior. In Europe, moderating inflation has allowed the ECB to ease policy more aggressively than the Fed.
- That said, risks remain. Global trade tensions, especially tariffs, remain a concern, as does tepid growth in key end markets like the U.S. and China. The U.S. is the EU’s largest export partner, accounting for about 5% of the EU’s GDP.
- Additionally, a stronger euro, spurred by a weaker U.S. dollar, could hurt the competitiveness of European firms in global markets. European companies have begun warning about the impact of a stronger euro on competitiveness in the U.S. and Chinese markets.
- Looking ahead, we could become more constructive on developed international equities if Europe were to pursue structural reforms, especially deregulation and capital markets integration.
- We also increased exposure to emerging market (EM) equities to a strategic weight, reflecting a more balanced outlook compared to U.S. equities.
- Similar to developed markets, we believe that currency risks and valuation discounts are now less likely to be drags on returns and may even enhance returns. When these factors are neutralized, EM equities look more attractive versus their U.S. counterparts, with dividends and earnings as primary return drivers.
- Historical EM earnings growth over the last 10 years has been distorted by structural changes to the MSCI EM index. These changes include the removal of Russia and greater inclusion of Chinese equities, particularly A shares.
- Looking forward, we believe EM earnings are likely to rival or exceed those of U.S. equities over the next decade, supported by favorable demographics and a more growth-orientated index composition. Near term EM earnings are projected to outperform U.S.
stocks this year and next. - Valuation remains a relative strength. EM equities continue to trade at meaningful discounts to the S&P 500 on both earnings and book value (with India the one exception). With less margin pressure from elevated wage costs and less saturation in tech and services, there is room for operating leverage to play out in future earnings cycles.
- While China remains an important component, its declining weight has lessened the drag from its underperforming tech sector and efforts to bring the private sector more firmly under state control. This shift may allow faster-growing markets with healthier corporate earnings trends to exert greater influence on the index-level growth trajectory.
- U.S. trade policy remains a significant risk (or opportunity) for EM. We need more clarity on this before considering whether to become more constructive on EM. For now, we believe a strategic allocation is appropriate.
Equity Indexes Characteristics
The Indexes mentioned are unmanaged statistical composites of stock market or bond market performance. Investing in an index is not possible.
For Index Definitions see: TouchstoneInvestments.com/insights/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 May; 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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