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Global economies and markets have traveled similar paths in terms of steep downturns in activity and equity prices. While the sequencing has been somewhat staggered, we think all markets are in the same boat: Volatility will persist, and an enduring recovery will require progress on virus containment. Global market rebounds will likely progress on different timelines, warranting (and potentially rewarding) international diversification.
Global economy to slow dramatically – Global GDP is likely to contract for the first time since 2009. We believe the key factor going forward will be the duration of the contraction. China has shown that output can bounce back somewhat quickly, but household spending may be a bit slower to ramp up than manufacturing and goods production. We think a second-half recovery is in the cards, but the pace will be dictated by progress in regional labor markets.
International rebound may lag – Covid-19 has hit the reset button, putting most economies back at the early stages of the market cycle. European economies didn’t enter this crisis in as vibrant a position as the U.S., and emerging economies will require demand for exports to support their rebounds. We expect financial markets to reflect a rebound faster than economic readings will, warranting ongoing international exposure in portfolios.
Market volatility favors diversification – We think international equity returns will rebound as risk appetite returns and investments trading at discounts to U.S. large-cap equities benefit from an increased search for cheaper valuations. International developed-market equities have performed roughly in line with U.S. equities this year and are now trading at roughly a 20% discount to domestic stocks, while also featuring a notably higher dividend yield. Emerging market equities have significantly outperformed lately, reflecting market sensitivity to progress in virus cases.
A focus on diversification will, in our view, be helpful in navigating ongoing volatility. We believe the eventual rebound will not be confined to domestic markets. Maintain an appropriate international allocation, favoring global equities over global fixed income and a larger exposure to developed markets versus emerging economies.
Diversification does not ensure a profit or protect against loss in a declining market.
Investing in equities involves risks. The value of your shares will fluctuate, and you may lose principal. Small- and mid-cap stocks tend to be more volatile than large company stocks. Special risks are inherent to international and emerging market investing, including those related to currency fluctuations and foreign political and economic events.