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The Power of Diversification: It's Time to Buy International Stocks

Dating back to the Great Recession, there’s been no place like home when it comes to investing performance. Led by large-cap technology companies, the Nasdaq and S&P 500 have experienced substantial outperformance relative to international equities over the past fifteen years.

And while big tech has performed admirably this year, there is evidence that a dominant shift toward international equities is underway. After more than a decade of lagging behind, the catalysts are present for international stocks to come back to the forefront, similar to the post-tech bubble era.

The Green Tailwind – A Weakening U.S. Dollar

The greenback enjoyed a stellar rise in 2022. Interest rate differentials between the U.S. and other countries rose as the Fed embarked upon its most aggressive hiking scheme in many years, raising rates more quickly than other central banks. That translated into more investors holding U.S. dollars, resulting in a significant strengthening versus a basket of other international currencies.

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The dollar is a trend driver for international markets traded in the U.S. A stronger dollar serves as a headwind for international equity investments. The below chart shows the dollar versus the MSCI EAFE Index, which is an equity index that captures large and mid-cap representation across 21 developed markets across the world excluding the U.S. and Canada.

StockCharts
StockCharts


Image Source: StockCharts

We can see the role that the dollar strength had last year, as well as how these markets have come back amid the dollar’s recent weakness. Also note the improving technical backdrop for developed international equity markets below. The iShares MSCI EAFE ETF EFA provides broad exposure to more than 800 stocks located in Europe, Australia, Asia, and the Far East.

StockCharts
StockCharts


Image Source: StockCharts

The EFA ETF recently hit a 52-week high and has risen more than 30% off of last year’s bear market lows. It’s a sign that global growth may come in better than originally anticipated. With inflation continuing to trend down along with a weakening U.S. dollar, international stocks are poised for more upside ahead.

Is it Time to Buy Emerging Markets?

Typically, investors with an international allocation have exposure to both foreign developed and foreign emerging markets. Similar to developed markets, foreign emerging markets have vastly underperformed the U.S. over the last decade. Chinese stocks in particular were hit hard in recent years due to extensive pandemic measures.

Over the past few years, there have been talks that Chinese firms would be delisted from U.S. stock exchanges due to a lack of transparency regarding Chinese accounting practices. But last year, American and Chinese regulators reached an agreement to allow accounting firms in China to share more information about the companies listed on U.S. exchanges. The agreement marked a turning point in resolving a major conflict that had originally pointed to a departure of China’s largest companies from domestic exchanges.

Emerging market valuations remain very attractive. In particular, many Chinese companies were unnecessarily targeted by regulatory and technology crackdowns in recent years. This has created great value propositions, with many emerging market stocks becoming appealing once again. As China continues to lift lockdown restrictions and eases up on some of the more assertive regulations, Chinese equities should continue to perform well.

Investing both domestically and internationally carries risks and it’s vital that investors understand the inherent hazards before taking positions. Risk management is paramount in today’s climate to reduce the probability of undesirable outcomes.

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iShares MSCI EAFE ETF (EFA): ETF Research Reports

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Zacks Investment Research