International Equities Monthly
- The Japanese yen has fallen through what many consider to be a critical level of 160 yen to 1 dollar. Many believe that without further BoJ intervention the yen is likely to fall further. We are not so certain.
- Over the past three years, the yen has fallen 32% relative to the dollar. This drop can largely be attributed to differences in interest rates. The Fed has undertaken one of its most aggressive tightening campaigns, raising the Fed Funds rate by 525 basis points. In contrast, the BoJ did not adjust their short-term rates until earlier this year with a modest increase of just 20 basis points.
- More significant activity has been observed in the longer end of the Japanese sovereign yield curve, which seems to have a greater influence on the yen’s value. Nearly two years ago, the BoJ allowed the yield on 10-year sovereign debt to rise from zero. It has since risen by about 100 basis points to yield 1.05% at the end of June.
- However, the Fed has stopped raising rates and is expected to begin lowering them later this year. Meanwhile, Japanese wages are growing at their fastest rate in over three decades. The Fed will likely be easing its policies as the BoJ tightens theirs, which should alleviate downward pressure on the yen.
- Japan’s currency is one of the most undervalued currencies based on purchasing power parity measures. Last month, The US Treasury placed Japan on a watch list for currency practices that “merit close attention.”
- The yen’s weakness has posed a significant challenge for U.S. investors. We believe this headwind will diminish as monetary policies in the U.S. and Japan begin to diverge and rates converge.
- The British and French elections took an unexpected leftward turn. While the British Labour Party was expected to win, the magnitude of their victory exceeded expectations. In France, the right-wing National Rally party was anticipated to secure a significant majority. However, no party won a majority, setting the stage for political gridlock.
- Markets are viewing political gridlock favorably, as both left- and right-wing policy proposals would have led to significant budget deficits. And while the British Labour Party won by a landslide, it was mainly due to their messaging of a more pragmatic and centrist approach to policy. With regard to the budget, Labour Party leaders emphasized respect for keeping it balanced.
- During the first half of this year, the MSCI EAFE index rose a healthy 11.5% in local currency terms. Unlike the S&P 500, returns were broadly based rather than narrowly driven. Stylistically, returns were fairly balanced with Growth stocks slightly outperforming Value. The biggest driver of local currency returns was Japan, with a total return of 20.5%.
- Unfortunately, when converting those returns into dollars, the gains were halved. The MSCI EAFE index returned just 5.8% in the first half. Japanese equities were the most affected, with the US dollar reducing more than two-thirds of the gains.
- Looking ahead to the second half of the year, we anticipate that the currency headwinds diminish or even turn into a tailwind. This would put the MSCI EAFE index on more equal footing with the US markets. As such, our focus has shifted toward relative earnings. Currently, the S&P 500 index shows a better earnings picture. However, changes in monetary policy could favor international stocks as we look towards 2025.
- We remain neutrally weighted in emerging market equities but have moderate concerns surrounding valuations, which have risen considerably this year. High EPS growth expectations need to be delivered to justify these high valuations.
- During the first half of this year, the MSCI EM index rose by 9.6% in local currency terms. The return characteristics were similar to the S&P 500 index, with Growth, Momentum, and Quality stocks driving returns. AI related stocks, such as TSMC, also led the market. Unlike the S&P 500, the EM index is not as concentrated at the top, and the rally had broader participation.
- In US dollars, the MSCI EM index returned 7.6%, reflecting modest dollar strength. Among the top 10 countries in the index, Brazil experienced the greatest currency decline at -11.2%. South Africa’s rand saw a modest gain, while India’s rupee was nearly flat against the dollar.
- At the start of this year, the EM index had more attractive valuations, with most valuation measures below their historical average. However, most valuation measures are backward looking. Earnings fell by double digits in both 2022 and 2023 and have not gained any ground year-to-date. This is why valuations have become extended. Earnings are expected to rebound significantly in the second half of this year and into 2025. Much of this growth is predicated on an upturn in global economic growth. By the end of this year, 78% of the central banks around the world are expected to be in easing mode.
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
Source: Bloomberg. Percent ranks are based on 30 years of monthly data as of the end of February; 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 Brian Cheyne, CFA, CIMA - Senior Investment Strategy Specialist, 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.
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