International Equities Monthly
- The U.S. dollar continues to trend downward, even as factors that traditionally support it, such as widening interest rate differentials and newly imposed tariffs, would normally push it higher. This divergence from historical norms suggests a deeper shift in investor sentiment and macroeconomic fundamentals.
- A key contributor is weakening growth expectations for the U.S. relative to our major trading partners. However, the passage of the budget bill, front-loaded with stimulus, and anticipated rate cuts in the second half of the year may help stabilize those growth expectations.
- Policy uncertainty may also be weighing on the dollar. The Trump administration's confrontational approach (particularly its unilateral use of economic tools) has undermined confidence in U.S. policy stability and reduce the dollar’s appeal as a safe-haven asset.
- From a valuation perspective, the dollar appears vulnerable over the long term. On a purchasing power parity basis, it remains overvalued relative to many major currencies. Moreover, the real trade-weighted dollar has also begun to turn lower, signaling a possible shift toward a secular decline.
- Structural imbalances, including the “twin deficits” (fiscal and current account), add further pressure. The U.S. requires consistent foreign capital inflows to sustain these deficits; if global demand falters, the dollar could face even more 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 increases have come primarily from 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 maintain a neutral stance on developed international equities, holding a strategic weight due to a more balanced risk/reward profile relative to U.S. equities.
- We believe that traditional headwinds, such as currency volatility and an expanding valuation discount, are unlikely to be performance drags going forward and may even turn into tailwinds. With these pressures easing, developed international equities are better positioned to compete with U.S. stocks, with earnings and dividends as the primary drivers of returns.
- In contrast, U.S. equities face headwinds from stretched valuations, elevated profit margins, and the likelihood of slower economic growth, pointing to potentially more subdued future returns.
- Internationally, the picture is improving. Germany’s suspension of its debt brake opens the door to fiscal stimulus that could boost growth, and Japan continues to push for more shareholder-friendly corporate behavior. Meanwhile, moderating inflation has allowed Europe’s central bank to ease policy more aggressively than the Fed.
- Risks remain, however. Global trade tensions, especially tariffs, are still a concern, as is tepid growth in key export 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 relatively stronger euro, 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 would consider overweighting developed international equities if Europe were to pursue deeper structural reforms, especially deregulation and capital markets integration.
- We are also neutral on emerging market (EM) equities, holding a strategic weight as the risk/reward profile becomes more balanced versus U.S. equities.
- Like developed markets, currency risk and expanding valuation discounts are less likely to hinder performance and may even enhance returns. With these factors neutralized, EM equities appear more competitive, with dividends and earnings expected to drive returns.
- Over the past decade, EM earnings growth has been distorted by structural changes to the MSCI EM index, namely, the removal of Russia and greater inclusion of Chinese equities, particularly A shares.
- Looking ahead, we believe EM earnings are likely to rival or surpass those of U.S. equities over the next decade, supported by favorable demographics and a more growth-oriented index composition. In the near term, EM earnings are projected to outperform U.S. stocks in both this year and next.
- Valuations continue to favor EM. Equities in this group trade at significant discounts to the S&P 500 on both earnings and book value metrics (India being the exception). With less margin pressure from elevated wage costs and less saturation in technology and services, there is room for operating leverage to play out in future earnings cycles.
- Although China remains a major component, its reduced index weight has reduced the drag from increased state control. This shift may allow other faster growing markets with healthier corporate earnings trends to exert greater influence on the index-level growth trajectory. We also note that China’s public companies have limited exposure to U.S. tariffs.
- 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 June; 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.
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