Liz Looks at: The International Landscape

By: Liz Young · June 01, 2023 · Reading Time: 5 minutes


There’s been a decent amount of chatter lately about international economies, markets, and all of the possible effects they could have on U.S. markets. There’s been much less chatter about whether or not international markets deserve a closer look, regardless of how U.S. markets may react to certain risks and possibilities that lie outside our borders.

A deep dive into the intricacies and geopolitical forces at play is beyond the scope of this piece, but we can take a look at some of the metrics we use to gauge the attractiveness of U.S. markets, to compare from a high level perspective.

For starters, no analysis in this environment can be done without considering the state of inflation. We’re much more familiar with the Fed’s goals of 2% inflation and maximum employment, but Central Banks around the globe have similar (if not identical) targets and are grappling, in many cases, with inflation that’s even more pesky than ours.

Perhaps it’s not a surprise that everyone is dealing with an inflation problem after the Covid global supply-chain shock, and subsequent tidal wave of demand, but what’s important to take away from the chart above is that large regions like Europe are an unfortunate example of sticky and persistent inflation. Even in the face of weak growth (Euro-zone real GDP growth has been below 1% q/q since Q4 2021) and bruised demand, inflation is still 7% in aggregate.

In fact, four of the five regions on this chart have seen a recent uptick or flat move in inflation recently. We’ve certainly made meaningful progress since peak inflation last summer, but aside from China, the fight isn’t over. Which likely means either more liquidity constriction to come, or at the very least, lagged effects of monetary tightening that haven’t quite rippled through yet.

Earn Your Keep

Inflation aside, what should matter to stock market direction is earnings. We know that S&P 500 forward EPS estimates have come down considerably since last summer, but companies have managed to hang in there perhaps better than expected. There’s still a risk for estimates to come down further, but they seem to have leveled out for the time being.

A read on European forward EPS actually looks attractive on a relative basis, with estimates rising over the same period, only showing a downtick recently. The difficult part of this picture is that we can’t tell whether European earnings are in fact more durable, or if the downward revisions have only just begun.

Given the stagflationary environment and persistent inflation problem, my hunch is that European earnings have room to fall. Not to mention, many European companies rely on U.S. and emerging market consumers to drive revenue, and if that consumption pattern doesn’t pick up, margins are likely to compress.

Speaking of emerging markets, earnings expectations for the broad EM index are underwhelming at best, and have seen a major downward revision cycle since spring of 2022. There are undoubtedly more risks embedded in EM countries, and more currency and market volatility, but the contrarian in me actually looks at the EM earnings line as a possibility that expectations are in a bottoming phase.

Being choosy about EM exposure remains critical. Geopolitical tensions between China and the U.S. and Taiwan should give investors pause. Additionally, China’s disappointing growth since fully reopening hasn’t proven to be the savior of a slowing consumer elsewhere. As such, a read of China’s economic activity is showing a decided contraction in the manufacturing sector, and if new lockdowns should occur, non-manufacturing sectors are likely at risk.

Needles in Haystacks

All right, maybe this read on international markets wasn’t exactly a pep talk of epic proportions. And maybe the U.S., although not without its challenges and high current valuations, still appears more attractive comparatively.

The point is that after many, many years of international indexes underperforming the U.S., it’s always worth revisiting to see if the tides could finally be shifting. Also, as a long-term investor, geographic diversification is an important element of portfolio construction.

At the current moment, international markets do not appear incredibly attractive on a broad index level, but I am starting to think about the pockets of opportunity in emerging markets. If the U.S. dollar weakens further, and if the possibility that EM earnings have bottomed becomes more of a reality, they’re probably worth a look. But be wary of too much exposure to China, which can be tricky in EM, given China’s monstrous weight in most indexes.

I’ll revisit this topic as time goes on, for now it’s probably just worth planting a seed and watching how it develops. The simple notion that there could be money to be made outside our borders is one we haven’t spent much time considering lately, but we could benefit from casting a wider net at some point in the not-too-distant future.


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