International outlook
After six straight quarters of underperformance, international stocks outpaced U.S. stocks in Q3 on the back of a softening dollar, rotating sector leadership and optimism around China’s stimulus announcements.
With major central banks easing policy, we expect the uptrend in global stocks to remain intact. The U.S. economy will likely continue to lead, but improving prospects elsewhere support the case for an appropriate allocation to the heavily discounted international equities.
China policymakers pull out the stops
A recent major development is China’s surprise announcement of a basket of policy stimulus measures targeting the general economy, the real estate sector and the stock market. Growth trends in the world’s second-largest economy have disappointed amid an ongoing slump in the property market and record-low consumer confidence.
To help stabilize and revive growth, policymakers lowered interest rates and mortgage costs, freed up funds for banks to increase lending, and pledged to provide greater fiscal support. Unlike other efforts in the past two years, the latest measures show a high degree of urgency and determination to deal with the economy’s challenges, triggering a sharp rally in Chinese equities.
Questions remain whether the promises for fiscal stimulus will be delivered and enough to prop up the economy. However, policy support, depressed investor sentiment and cheap valuations should improve the near-term outlook for China and emerging-market equities.
Europe hits a soft patch
After a modest recovery in the first half of the year, European economic activity measures have recently softened, indicating weakening growth at the end of Q3. Germany, the region’s largest economy, has stagnated over the past two years, weighed down by sluggish manufacturing activity. In contrast, Southern European countries have outperformed, boosted by strength in services.
We expect positive but slow growth for the region in the quarters ahead. Together with cooling inflation, this should give the European Central Bank (ECB) confidence to continue gradually cutting interest rates.
Global easing cycle may broaden bull market
A new cycle of central bank rate cuts across most regions (except Japan) can help drive a recovery in global economic activity. Cyclical sectors carry a higher weight in international indexes and could benefit from a pause in tech enthusiasm as sector leadership broadens on the back of easier rate policy.
While the relative earnings momentum remains in favor of the U.S., the record 35% valuation discount of international equities and a softer U.S. dollar suggest overseas stocks may offer catch-up potential and provide diversification benefits.
Action for investors
We recommend overweighting U.S. stocks and underweighting international equities based on the relative economic and earnings trends. Within fixed income, consider overweighting emerging-market debt, which has higher interest rate sensitivity and historically outperforms U.S. bonds in periods following Federal Reserve rate cuts.
DisclaimerImportant information: Investing in equities involves risk. The value of your shares will fluctuate, and you may lose principal. Investing outside the United States involves risks, such as currency fluctuations, periods of illiquidity and price volatility. These risks may be heightened in connection with investments in developing countries. |