International Equities Monthly
- Despite geopolitical stress, the dollar has remained broadly flat year-to-date, reflecting a balance of forces, including still supportive but no longer widening rate differentials, less concentrated safe-haven demand, and a gradual erosion of U.S. macro advantages at the margin.
- The U.S. Dollar Index has been range bound between 97 and 100 over the past year. While short term dollar moves have generally tracked news surrounding the Strait of Hormuz, the magnitude of those moves has been far smaller than the swings in oil prices, suggesting the dollar has become only partially tied to the energy narrative.
- We continue to believe both sides are economically incentivized to restore shipping flows, though neither side currently appears willing to make the concessions necessary for a deal. Just as importantly, we do not see the degree of economic pain needed to force either side to the table, raising the risk of extended closure. That said, once markets begin to believe reopening is becoming more likely, we would expect the dollar to weaken.
- Historically the primary near-term driver of currencies has been relative short-term interest rates. Based on a simple regression, the dollar is currently trading in line with what one would expect based on the spread between U.S. 2-year Treasury yields and a weighted average of the 2-year sovereign yields across developed international markets. In other words, for all the geopolitical drama, the bond market is still driving the bus.
- Over the longer term, however, we continue to believe the backdrop for the dollar remains challenged. Large fiscal deficits, elevated policy uncertainty, and gradual reserve diversification away from the dollar remain meaningful structural headwinds.
- Taken together, while near-term dollar movements may continue to swing with geopolitical headlines and relative interest rates, we see little evidence that the structural headwinds facing the dollar have diminished. As a result, we maintain our view that the dollar has likely peaked on a secular basis, reinforcing a supportive backdrop for U.S.-based investors maintaining exposure to international equities.
- We maintain a neutral strategic allocation to developed international equities. We believe the reopening of the Strait would likely improve
the macro backdrop by reducing energy costs and easing inflation pressures, although higher European interest rates and an increasingly
concentrated earnings picture keep us from getting too excited. - The resilience of the euro during the extended Strait closure suggests Europe may not be as fragile as the macro narrative suggests.
Historically, a combination of higher energy costs, slowing growth, rising inflation, and rising expectations for ECB tightening would likely
have produced a weaker euro. - That said, several of Europe’s earlier sources of return strength–including autos, financials, luxury, and defense–appear less durable than
they did earlier in the year. In addition, energy has been one of the largest contributors to positive earnings revisions, and falling oil prices
may reduce that support going forward. - Beyond Energy, the earnings growth story is becoming increasingly narrow. Just like here in the U.S., AI and AI infrastructure stocks are
becoming a growing share of earnings growth and returns. Unlike the U.S., those companies make up a much smaller portion of the index. - Japan presents a more encouraging picture. Consensus 2026 earnings estimates have seen strong upward revisions relative to Europe,
supported by AI-related businesses and financials (due to rising rates). Japan has a number of companies that have strong global positions
in automation, robotics, and semiconductor equipment which stand to benefit from AI spending and broader digitalization trends.
Importantly, earnings revisions and market performance have shown broader participation across sectors than we are seeing in Europe. - Over the longer term, developed international equities continue to offer attractive characteristics, including lower valuations, higher
dividend yields, potential currency tailwinds, and less reliance on a narrow group of U.S. mega-cap stocks.
- Emerging markets have a more complicated picture. In late March we tactically reduced our emerging market (EM) allocation because
we believed a prolonged closure of the Strait of Hormuz would disproportionately affect many EM economies. We became increasingly
concerned about elevated near-term risks stemming primarily from the energy shock tied to the Iran conflict. - Asia represents roughly 80% of the MSCI EM index and remains particularly exposed because of its dependance on imported Middle
Eastern energy. Disruptions to the Strait of Hormuz raised energy costs and created meaningful headwinds for growth, inflation, and
external balances across the region. - While that assessment proved broadly correct from an economic perspective, it did not lead to relative market underperformance.
Instead, EM outperformed with returns becoming increasingly concentrated in a small number of AI-related semiconductor companies:
TSMC, Samsung, and SK Hynix. Excluding those three stocks, the broader EM index looked much weaker. At the same time, they cannot
now be ignored, as together they account for nearly 30% of the index. Even a passive investor is implicitly taking active bets on these three
stocks. - Looking ahead, the gradual reopening of the Strait removes an important macro headwind for many EM economies and should improve
the outlook for energy importing countries across Asia. - However, we are not yet convinced this warrants a return to an overweight position. EM leadership is now unusually narrow, with
a handful of stocks driving a disproportionate share of returns. While semiconductor demand remains strong, the pace of recent
outperformance may be difficult to sustain given elevated expectations. - We also note that economic conditions in China have softened despite efforts to minimize the impact of higher oil prices. As such, lower
oil prices may not provide the same degree of support for China that may be seen in other Asian countries. - Taken together, while a reopening of the Strait may benefit a number of EM economies, narrow leadership and divergent country level
fundamentals support our slightly more cautious tactical positioning.
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 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.
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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.
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