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U.S. vs. Developed Markets Equities Insights

By Richard "Crit" Thomas, CFA, CAIA
International Equities
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International Developed (EAFE) vs. U.S.

Investing in developed international stocks has historically provided investors with:

  • Diversification: portfolios that included international stocks have historically produced higher risk-adjusted returns (Flavin and Panopoulou).
  • Opportunity: 76% of publicly traded companies are not U.S.-based (Source: MSCI) and 40% of the global market cap resides outside of the U.S. (Source: Bloomberg). Why limit equity exposure to just a fraction of the total market opportunity set?

But why now...

Conclusion:  We moved to an EAFE underweight at the start of Russia’s invasion of Ukraine. While relative valuation remains attractive, we see near-term risk to relative earnings prospects, though the headwinds from the stronger dollar appear to have dissipated. We also think that the sanctions against Russia will remain in place for an extended period. We believe that the U.S. economy and markets are more insulated from reduced trade with Russia and higher commodity prices.  

Relative Valuation

Relative valuation in a historical perspective clearly favors EAFE, and versus its own history, our combined valuation measures rank the MSCI EAFE Index in the bottom third. For the active manager, we believe there may be opportunities to uncover, but we also recognize that the risk profile has also increased, partly offsetting the valuation differential.

Relative Valuation Measures Based on the MSCI EAFE® Index/S&P 500® Index as of November 2022 &  Relative Valuation* MSCI EAFE® Index/S&P 500® Index Monthly data: March 1995 through November 2022

Relative Earnings Prospects

  • Relative price performance and relative earnings growth have historically followed a similar path. Relative earnings growth since mid-2008 has favored the S&P 500® Index versus the MSCI EAFE® Index.
  • In local currency terms, earnings for MSCI UK and Europe have been revised up sharply for 2022. This may seem odd given the backdrop of slowing economic growth and onerous energy prices. The composition of the indexes holds the key where there is significant energy exposure as well as large global companies that source more income outside of their currency footprint than inside. Their weak currencies became a competitive weapon. We expect much of this to reverse in 2023.
    Relative Earnings* MSCI EAFE® Index/S&P 500® Index Monthly data: May 1995 through November 2022

Monetary Policy/Currency

  • Historically the U.S. dollar typically moves directionally with U.S. stock relative performance. A sustained period of U.S. dollar weakness would provide a tailwind for international stocks.
  • The dollar has been strengthening versus developed currencies over the last 12 months. The dollar’s strength has main been a function of monetary policy, changes in current account balances due to the war in Ukraine, and a flight to safety in a time of uncertainty. The dollar does look extended and due for a pullback as it is trading well above fair value. While higher short-term rates could still support the dollar, historically, the dollar peaked before the Fed stopped increasing rates.
    Currency and Relative Performance Monthly data: December 1985 through November 2022Glossary of Investment Terms and Index Definitions

Thomas J. Flavin, Ekaterinin Panopoulou, “On the robustness of international portfolio diversification benefits to regime-switching volatility,” Journal of International Financial Markets, Institutions and Money, 2009.

This commentary is for informational purposes only and should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation to buy, sell or hold any security. There is no guarantee that the information is complete or timely. Past performance is no guarantee of future results. Investing in an index is not possible. Investing involves risk, including the possible loss of principal and fluctuation of value. Please visit touchstoneinvestments.com for performance information current to the most recent month-end.

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.

Touchstone Funds are distributed by Touchstone Securities, Inc.*
*A registered broker-dealer and member FINRA/SIPC.

Not FDIC Insured | No Bank Guarantee | May Lose Value

crit thomas global market strategist

Richard "Crit" Thomas, CFA, CAIA

Global Market Strategist
Crit is responsible for examining and evaluating economic conditions, generating insights and providing a sharpened perspective on investment strategies for enriched portfolio construction.

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