Heading into 2018, International Assets Are Positioned for Outperformance
Heading into 2018, we remain positive on global equities and believe the outperformance of international risk assets can continue, despite the strong year-to-date returns in global markets.
In the years following the Global Financial Crisis, uneven global growth created headwinds for risk assets outside the US. Typically, one or two regions would show improvement, while other regions decelerated. Over this period, the US economy was the relative leader, and the dollar strengthened. However, since early 2016, global growth has begun to accelerate fairly uniformly against a backdrop of still-highly accommodative central bank policies and recently implemented economic reforms (Figure 1). With non-US economies in earlier-stage recoveries, we expect supportive conditions for international risk assets to remain in place.
FIGURE 1. SYNCHRONIZED GLOBAL GROWTH SUPPORTS OVERSEAS ASSETS Leading Indicators (OECD Main Economic Indicators)
Source: Macrobond, using OECD, Composite Leading Indicators, seasonally adjusted.
Dollar Weakness Provides a Tailwind to International Risk Assets
In addition to improving global growth and attractive relative valuations, non-US equities are positioned to benefit from a US dollar that is at least 20% overvalued and appears to be entering a period of prolonged weakness. We may be seeing the earlier stages of this trend, as the dollar is on track for the worst year since 2003, down approximately 7% year to date.
The path of the dollar will continue to be a key variable for overseas markets. As Figure 2 shows, the returns of non-US equities have been highly correlated. Historically, as the dollar has weakened, we’ve seen an outperformance of foreign equities greater than the currency return differential. We believe the dollar is likely to weaken further versus the trade-weighted basket, which would support continued outperformance in foreign equities. Figure 2 also illustrates that regime changes (strong-dollar-to-weak-dollar) have historically been multi-year phases.