We have argued for quite some time that equities around the world were and still are “the only game in town” when compared to other “mainstream” competitive investments. Bonds are extremely expensive with interest rates historically low (i.e. near 0%) and cash which used to earn something, earns an investor nothing today. So, the default investment of choice has been the stock market and we believe for the foreseeable future will continue to be – with prices underpinned by surprisingly strong sales, earnings, cash flow and increased dividends. Investors have bid up equity prices around the world, but particularly so in the U.S. – leaving the U.S. market expensive versus others.
Over long stretches of time, U.S. and international markets have “ebbed and flowed” countercyclically as seen in the following chart.
International stocks have clearly underperformed U.S. equities for quite a few years recently and should be ripe for a relative performance reversal, as has happened many times in the past. What could spark this change of fortune for foreign stocks? We think a change in the view of the dollar will provide the “match” to light international equity outperformance. Why? Because the dollar has no interest rate premium as compared to other currencies. It used to be the case that international investors could get a higher interest rate on U.S. dollar deposits. That premium has vanished and the dollar has started to underperform other currencies, as demonstrated in the top two lines in the chart below showing both the Euro and the Japanese Yen appreciating in value since July.
With a potentially weak dollar enticing investors to look afar, why international equities? Again, as in the U.S., foreign bonds are expensive comparatively to stocks with international interest rates low. Cash investments are similarly unattractive. Further, with a COVID vaccine near at hand, American investors seem to be more willing to take on risk – to invest overseas – and international investors facing a weakening dollar will prefer to stay in their local markets. As earlier mentioned, foreign stocks are cheap as compared to their U.S. counterparts. Also, investors invest where there is growth and certainly countries like China, Vietnam, India and Taiwan (just to name a few) are growing more rapidly than the U.S. Finally, over the years as capitalism has spread, worthy competitors to U.S. corporations (think Alibaba, Taiwan Semiconductor, Roche, AIA Group) have prospered. There are investable opportunities all around the world.
So, we would encourage investors to look “near and far” to find worthwhile investments for a portfolio. Overlooking the rest of the world which is home to 96% of the earth’s population and 85% of its economic activity could be a mistake.
HAVE A HAPPY HOLIDAY SEASON FROM ALL YOUR FRIENDS AT BALDWIN!