Cheers for International Stocks Are Getting Louder

Interest in global equities over the U.S. is starting to heat up.

Investment firms, including Comerica Wealth Management, Wolfe Research, and Northwestern Mutual Wealth Management, are shifting to an overweight position in equities outside the U.S., with many overweighting emerging market stocks. Those firms cite the weakening dollar and stronger global growth against that of the U.S. as the world emerges from the pandemic-induced recession.

Since Tuesday, the S&P 500 has underperformed global indexes such as the Stoxx Europe 600 and iShares MSCI Emerging Markets ETF. The S&P 500’s performance bucks a trend of underperformance for global stocks against the U.S. seen all year.

“We’re starting to see broader interest as investors are looking for broader opportunities,” said Mike Loewengart, managing director of investment strategy at E*Trade. “We are on the cusp of seeing international stocks outperform.”

That change is largely due to positive stimulus news in Europe. The European Central Bank said this week it will increase the size of its bond-buying program by 500 billion euros, or $600 billion, to further support the economic recovery in the bloc. Plus, a $900 billion EU fiscal stimulus package is in the works.

Many economists say the billions of doses of vaccines expected to be distributed globally in the coming year will drive outsize economic momentum abroad versus in the U.S. Ham, for one, noted that ECB President Christine Lagarde mentioned that the central bank may not have to use its entire toolbox to support the recovery, “which gives investors confidence that the EU is doing better than the U.S.”

Consensus estimates for 2021 global gross domestic product growth is 5.4% and 5.2% for the EU. Emerging market GDP is expected to grow 6.3% for 2021. For the U.S., growth is expected at just 3.8%. That’s primarily because Europe’s GDP took a larger hit in 2020. And for any stock outside the U.S., a weak dollar is a tailwind because its value increases when converted. Many on Wall Street expect the dollar to continue its downtrend. The differential between global and U.S. GDP growth rates and the shrinking premium on U.S. Treasury yields against foreign yields are both driving expectations of continued dollar weakness.

“A potentially weaker dollar would benefit US multinational companies’ profits, boost returns of international investments for dollar-based investors” wrote LPL Financial strategists in a note.

Near-term economic growth can drive global stocks higher, but valuations outside the U.S. are far lower than in the U.S., potentially providing even more upside.

For the EU, the average stock on the Stoxx Europe 600 Index trades at just above 18 times earnings per share forecasts for the next 12 months. That’s much lower than the average S&P 500 earnings multiple of 22.1.

One caveat is that EU stocks have been trading at a valuation discount to U.S. stocks in the past several years and the valuation gap has slimmed of late. Observing the average earnings multiples on the Stoxx Europe 600 and S&P 500 versus those now, EU stocks have already begun to catch up to U.S. stocks in terms of valuation. In the past five years, the multiple on the Stoxx Europe 600 was 20% lower than that on the S&P 500. Now, stocks on the European index trade at just a 17% discount to the U.S. benchmark index.

Sure, valuations abroad have expanded some, but those levels might be appropriate. And we’ve yet to see sustained outperformance this year for a global group of stocks benefiting from several tailwinds.

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