Why 2020 could be a big year for international stocks over US equities

Eased trade tensions between the United States and China and signs of a strengthening global economy could be good news for international equities and European stocks in particular, according to market strategists.

Some analysts and strategists have been urging clients to move more of their portfolio into international stocks. That advice follows a strong run for the U.S. market that widened the gap between domestic and foreign equities and capped a dominant decade for U.S. stocks.

Since 2010, the S&P 500 rose more than 188%, an annualized rate of about 11.2%. The MSCI World ex US index saw much more modest gains, climbing 50.5% overall or roughly 4.2% per year.

“If your asset allocation has significant domestic exposure and little-to-no international equity exposure, we think now is an excellent time to make a shift,” Bespoke Investment Group said in a note to clients last month.

Last year was strong for stocks around the world, but the U.S. still took the lead. The international index rose 18.1%, but the S&P 500 jumped more than 28%.

The global stock market got a negative shock in the first trading days of 2020. Equities slipped following the U.S. airstrike that killed a top Iranian military leader. However, oil prices have moderated and stocks have avoided a multi-day selloff.

Much of the optimism about international markets comes from global economic data, where both hard and soft indicators suggest that the global slowdown may have bottomed out. Measures of manufacturing and global trade have ticked up in recent months.

“We have reasons to believe that this improvement in manufacturing and trade can be sustained,” Morgan Stanley chief economist Chetan Ahya said in a note to clients.

The Eurozone is one area where investors should increase their exposure, according to Mark Luschini, chief investment strategist at Janney Montgomery Scott, in part due to positive signs about the Chinese economy.

The European stock market is more sensitive to the global economy than the U.S. market, Luschini said, similar to equities in emerging markets. Because Chinese growth has such a large impact on the world’s economy, even a slight improvement could spill into international markets, Luschini said.

“If China merely stabilizes its growth from the deceleration that it’s had the last couple years, that’ll go a long way to putting a positive impulse into these equity markets,” Luschini said.

Europe was home to a few countries where stocks saw better years than the United States in 2019, including Russia and Greece.

Italy was one of the best performing G-7 countries last year, with the FTSE MIB roughly matching with the S&P 500 last year with a 28.3% gain, measured in euros. The Stoxx 600, a major European index, gained 24% last year.

Investors can gain exposure to all of Europe through total market exchange traded funds for the region, such as Vanguard’s FTSE Europe ETF, or individual countries through a more targeted funds like iShares MSCI Germany ETF.

Another opportunity for return from international markets comes from the relative strength of the dollar. If investors buy international stocks and the dollar weakens against that foreign currency, the total return could be more than the stock return once the currency is converted back to dollars.

The dollar index is currently about 2% off its 52-week highs, but is roughly 9% above its recent lows in early 2018.

“The so-called real broad dollar surged in 2015 and 2016, with another decent rally in 2018, but not much change in 2019,” Bespoke said. “As a result, the dollar looks relatively strong but not dramatically by any means.”

The strength of the dollar is determined in part by the purchasing power of other countries, so global growth could mean that other currencies strengthen against the dollar.

“If you do see emerging growth abroad, that should lead to a relatively weaker dollar, which would feed into the returns for U.S. based investors that are earned in overseas markets,” Luschini said.

Tensions in the Middle East, and the potential for elevated oil prices, is one of several risks that world markets face in 2020.

“The risks to the recovery will be if trade tensions between the US and China escalate again, a rise in geopolitical tensions in the Middle East, or if late-cycle challenges in the US … result in a more pronounced rise in inflation,” Ahya said.

Another risk could be a change in interest rate policies from the world’s central banks. Sweden’s Riksbank bucked the trend of easing last month, when it raised rates back to zero. The global average for policy rates is expected to rise to 2.06% this year from 1.92% at the end of 2019, according to Bespoke.

However, Luschini said it is unlikely that many central banks follow Sweden’s lead in tightening monetary policy.

“I think there’s going to be a generally shared reluctance to raise interest rates,” Luschini said.