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: 77% of publicly traded companies are not U.S.-based (Source: MSCI) and 59% 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 remain at an equal weighted stance. MSCI EAFE Index valuations look very attractive relative to the S&P 500® and we are looking for an opportunity to move to an overweight. The significant amount of monetary stimulus seen around the globe and potential trade resolutions are likely to help the relative fundamentals. At this time we are waiting for signs of economic traction from the monetary stimulus and greater certainty with respect to trade before upgrading.
Our views on Developed Markets are based on historical relative valuations, relative earnings prospects vs. the S&P 500 Index, and monetary policy.
- Relative valuation in a historical perspective favors EAFE, with both relative Price/Book and Price/Sales at historically low levels.
- At the end of November 2019, the S&P 500® Index closed at a price that was more than 100% above the 2007 peak, while the MSCI EAFE Index would need to rise 21% to get back to its 2007 peak. As of November 2019, on a forward P/E basis, the MSCI EAFE Index was selling for 14x and had a dividend yield of 3.4%. For the active manager, we believe there are many opportunities to uncover.
Sources: Bloomberg, MSCI
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 until mid-2016.
- MSCI EAFE Index earnings began to outpace the S&P 500® Index in 2017. But since then, S&P 500® earnings have done better due to the tax cut in 2018 and due to relative economic performance to date in 2019.
- What looked like a temporary deceleration in economic growth in Europe and Japan in 2018 continued into the 2019 as global trade volumes decelerated. Earnings estimates for 2020 have come down, making for a low hurdle. We are beginning to see early signs of a bottoming in economic growth in Europe. A trade truce between the U.S. and China may help feed an economic recovery not currently priced in the markets.
Sources: Bloomberg, MSCI
- While monetary conditions outside of the U.S. continue to be more market friendly, the impact on their economies (namely Japan and Europe) has been limited. That said, the number of central banks around the world that have reduced interest rates in 2019 continued to increase and has reached levels not seen since the last recession. While the European Central Bank (ECB) and Bank of Japan (BOJ) are limited in what more they can do monetarily, we are starting to see actions on the fiscal front including a large stimulus package in Japan to help offset the negative impact from a large consumption tax increase. These fiscal stimulus efforts could even the playing field between EAFE and the U.S.
- While not directly tied to monetary policy we also need to consider numerous geopolitical risks including Brexit negotiations, populist election wins in Germany, Italy, and Spain, Italy’s budget deficit, a planned October 25% consumption tax increase in Japan, and potentially disruptive bilateral trade talks with the U.S. in the near future.
Bank assets represent the sum of banking balance sheet assets within an economy (including private or commercial banks, central banks or both). The year/year growth in these assets is representative of money creation and contraction within the economy. The picture is not fully representative of the economy as it excludes non-bank financial institutions (i.e., shadow banks).
Sources: Bloomberg, Federal Reserve, Bank of Japan, European Central Bank
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 advisor 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.
Not FDIC Insured | No Bank Guarantee | May Lose Value