International Equities Monthly
- The U.S. dollar found support in July. The passage of the budget bill, front-loaded with stimulus, along with resilient economic data (not including the August 1 employment report), helped stabilize economic growth expectations. Additionally, newly retained tariff agreements helped reduce some uncertainty in the short term.
- The dollar appeared to be returning to fundamentals. Higher U.S. yields, relative to other developed markets, reversed a previous trend that began when the Liberation Day tariffs were introduced. Although U.S. economic growth slowed in the first half, it still outpaced Europe and parts of Asia. Lastly, the dollar regained its safe-haven status on days of heightened geopolitical tension.
- Despite July’s rebound, we do not view it as the start of a sustained strengthening trend. Over the medium term, we continue to see reasons for the dollar to stay in check.
- From a valuation perspective, the dollar appears vulnerable. It remains overvalued relative to many major currencies on a purchasing power parity basis. Moreover, the real trade-weighted dollar has also begun to turn lower, hinting at a potential shift toward a secular decline.
- Structural imbalances, including the “twin deficits” (fiscal and current account), add further pressure. The U.S. depends on constant foreign capital inflows to fund these deficits; if global demand falters, the dollar could weaken.
- 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 summary, while July’s rally was notable, longer-term fundamentals suggest continued vulnerability for the dollar. This supports maintaining a strategic allocation to international equities for U.S.-based investors.
- We maintain a neutral stance on developed international equities.
- Recent tariff agreements with Japan and Europe were generally received positively by the markets, removing worst-case trade scenarios, at least for now. Nonetheless, both Japan and Europe still face trade headwinds with the U.S. and China.
- 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.
- Additionally, the Trump administration’s renewed focus on brokering a truce between Russia and Ukraine would be a clear positive for Europe if meaningful progress is made.
- In contrast, U.S. equities face several headwinds: stretched valuations, elevated profit margins, and the likelihood of continued slow economic growth, all pointing to more subdued future returns.
- Meanwhile, the international backdrop continues to improve. Germany’s suspension of its debt brake paves the way for fiscal stimulus, 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.
- However, risks persist. Global trade tensions remain unresolved, and growth in key export markets, particularly the U.S. and China, remains tepid. The U.S. is the EU’s largest export partner, accounting for about 5% of the EU’s GDP.
- Looking ahead, we would consider overweighting developed international equities if Europe were to pursue deeper structural reforms, especially deregulation and capital markets integration.
- We remain neutral on emerging market (EM) equities, holding a strategic weight due to a more balanced risk/reward profile relative to U.S. equities.
- As with international developed markets, currency risk and valuation discounts are less likely to weigh on returns and may even enhance returns. With these headwinds easing, EM equities appear more competitive, with dividends and earnings expected to drive returns.
- What tariffs? EM equities have rallied strongly year-to-date through July: South Korea is up 45%, China 23%, and the broader EM index is up 18%. While this rally may seem at odds with a backdrop of global trade tensions and tariffs, there are some plausible explanations.
- EM underperformed in 2024, setting the stage for a rebound on both valuation and sentiment grounds.
- Supply chain realignment has benefited some EM countries. For instance, Mexican stocks are up 31%.
- Developed market central banks have paused or cut rates. Emerging markets tend to benefit from flows into riskier assets when there is sufficient liquidity created by central banks. Additional help has come from EM central bank easing, such as in Korea and China.
- Many emerging markets have seen solid earnings growth. EM is on track to deliver higher earnings growth than developed markets, including the US, in 2025 and 2026.
- A weaker dollar has eased pressure on many EM countries that issue debt denominated in dollars.
- Many EM companies are domestically focused and thus less exposed to U.S. tariffs.
- That said, the tariffs remain unsettling, and given the strong rally in these markets, a pause may be warranted.
- Looking ahead, we believe EM earnings are well-positioned to rival U.S. earnings over the next decade, supported by favorable demographics and a more growth-oriented index composition. Valuations remain compelling. Equities continue to trade at a meaningful discount to the S&P 500 on both earnings and book value (India being the exception). Lower wage pressures and less saturation in tech and services allow for future operating leverage.
- In our view, EM equities should remain a strategic holding, offering diversification and long-term growth potential.
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.
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