International Equities Monthly
- After a sharp decline in the first half of the year, the U.S. dollar has stabilized. Its next move is uncertain, but we believe that it is unlikely to resume the secular rally that it has enjoyed over the last 15 years.
- The strong rally in gold could be interpreted as evidence that foreign central banks and investors are seeking alternatives to the dollar. While we believe this is true in a broad sense, the recent surge in gold prices appears largely speculative in nature. Over the past two months, gold has rallied more than 20%. Yet, during this same period, the dollar has edged higher and long-term Treasury yields have fallen, neither suggesting that investors are rotating out of U.S. assets in favor of gold.
- Fund flow data indicate that foreign investors have been reallocating away from U.S. equities. Dollar weakness seen in the first half has been a contributing factor, as it has reduced returns on U.S. stocks for foreign investors. In addition, foreign investors are increasingly wary of concentration risk in U.S. markets, elevated valuations, and rising country-specific risks under the second Trump presidency. Europe and Emerging equity markets have been the main beneficiaries of this reallocation.
- In the near term, we believe the dollar’s direction will hinge on the Fed – specifically, how much and how soon the Fed decides to cut rates. Recent economic data point to resilience, suggesting that rate cuts may be fewer and later than expected. This could place modest upward pressure on the dollar in the short run.
- Over the longer term, we believe structural forces are likely to restrain the dollar. High valuations, widening trade and fiscal deficits, and uncertainty surrounding U.S. fiscal and trade policy are causing foreign investors to employ a greater degree of currency hedging and seek alternatives.
- Taken together, while the near-term outlook is less certain, the fundamentals point to longer-term vulnerability for the dollar, supporting the case for U.S.-based investors to maintain strategic allocations in international equities.
- We maintain a neutral strategic allocation to developed international equities.
- Traditional headwinds such as currency volatility and expanding valuation discounts are easing and may even become tailwinds. With these pressures subsiding, developed international markets are better positioned to compete with U.S. equities, with earnings and dividends expected to be the primary drivers of returns.
- Europe’s economy remains constrained, with 3Q GDP expected to grow just 1.0% year over year, while revenue and earnings are projected to be flat. Forward guidance will be key for setting expectations for 2026, when earnings are forecast to grow 11% after three years of stagnation. Strong price and earnings performance from European banks has been a healthy sign for Europe’s economy, and Germany’s suspension of its debt brake opens the door to fiscal stimulus.
- Near-term conditions for the U.K. appear more fragile, as commodity-linked sectors continue to face headwinds. However, given low expectations and depressed valuations, U.K. equities have upside potential heading into 2026.
- Japan’s markets have so far shrugged off political noise and signs of slower growth. That could change if the Bank of Japan (BOJ) turns more hawkish and raises rates to rein in nagging inflation. The BOJ is currently expected to hike once at the end of the year, but we believe slowing growth and negative real wage growth will keep it from adopting a more aggressive stance. If we are wrong, higher rates could strengthen the yen, offsetting one of corporate Japan’s competitive advantages.
- Performance for the MSCI EAFE index has diverged significantly from that of the S&P 500. Performance for the MSCI EAFE has been driven by the Value style. In fact, the MSCI EAFE Value index has meaningfully outperformed the S&P 500 over the past one and three years and matched it over five years. S&P 500 performance has been dominated by the Growth style. Differentiated return streams are generally seen as a positive from an asset-allocation standpoint.
- Looking ahead, 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. mega cap stocks.
- We maintain a strategic weight in emerging market (EM) equities, reflecting a balanced risk/reward profile relative to U.S. equities.
- As in 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 EM assets by allowing local policymakers more room to stimulate growth and could boost capital flows. Historically, EM equities have outperformed both U.S. and developed international stocks during Fed easing cycles that did not coincide with recessions.
- EMs also provide significant exposure to the technology sector (the largest MSCI EM index sector 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 growth appears well-positioned to rival U.S. earnings growth over the next decade, supported by favorable demographics and a more growth-oriented index composition versus history. 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 at the same time that 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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