Transcript
[MUSIC PLAYING]
Welcome to Market Perspectives, a Mercer Advisors podcast. Today, we’re going to be talking about the surprising strength of international stocks, especially European. I’m Josh Zumbrun. I’m the director of External Communications here at Mercer Advisors. And I’m joined today by Don Calcagni, our chief investment officer. Don, thanks so much for being here today.
Josh, it’s great to be here again. Thank you.
So we talked about this a little bit in episode 22. In the first quarter, European stocks beat US stocks by a considerable amount. But that episode was before the latest round of global tariffs were announced.
So just to recap a little bit, the tariffs were announced April 2. Then for several days, markets fell just around the world. On April 7, the S&P 500 briefly entered bear market territory. And since then, things have rebounded a little bit.
So a lot has happened in just a month, and it’s already time to retake stock a little bit of where things stand after all the turmoil of the past month. So, Don, walk us through what’s happened over the past month to US and international stocks.
Just high level, Josh. The announcement of the tariffs on April 2 were pretty significant. The market was expecting tariffs to be announced. President Trump ran on a platform where he was very clear that he was very pro tariff and was going to put tariffs in place.
I think the severity of the tariffs, the pervasiveness of the tariffs applying to all global trading partners really caught the market off guard. And we saw the market digest that information very rapidly in the form of a very severe sell off that candidly lasted for what? About a solid 10 days. Maybe some stop and starts.
But I think as the market has started to digest that information. To be fair, the administration has walked back a lot of their tariff announcements. They put in place a 90-day pause.
Treasury Secretary Scott Bessent has communicated that this is really unsustainable vis a vis China and has given the market some hope that perhaps these tariffs ultimately, once implemented, will not be as severe.
And I think based on that feeling, that sediment, that information, the S&P has recovered a bit from the depths that it saw on or about April 7. But that doesn’t change the fact that markets are still negative for the month.
The S&P is negative for the month. It’s negative for the year. It’s down about 5% on the whole year to date through yesterday’s close. Yesterday was April 30. Today is May 1 when we’re recording.
And non-US equities especially developed European equities have actually continued to do quite well. So well that non-US equities at the moment developed market. Non-US Equities are up anywhere from 10 to as high as 13% 14% 15% for the year. So that’s about, let’s call it, a 20% out performance, almost year to date relative to US stocks.
That’s a big gap. And especially for Europe to be that far ahead of the US is quite unusual in recent years.
Absolutely correct.
So Don, what can we say about some of the drivers of this? When we talked about the topic a month ago, one of the big things that came up was that there’s a big currency effect here. What can we say about how this is driving the difference in US and European stock performance?
Yeah, I mean, absolutely. You mentioned the currency effect. That is a huge driver of what is happening here. What is effectively happened since the tariff announcement has been what some journalists have dubbed the sell America trade.
So we’ve seen a very violent, pretty dramatic sell off in US based assets across equity markets, fixed income markets and so on and so forth. So much so that we’ve actually seen a decline of about 8% or 9% year to date in the value of the US dollar relative to non non-US currencies. And so, Josh, that 8% or 9% decline in the dollar is what we call the currency effect.
So when you look at a non-us investment holding, for example, that may be up 15% year to date. About 8% or 9% of that is simply due to the fact that the value of the US dollar has declined 8% or 9%.
And so that sell off in the dollar, the relative decline in the demand globally for US dollars is a powerful tailwind for investors that own those non US assets. And so that currency effect is one of many reasons why we’re seeing this pretty dramatic outperformance year to date.
But it’s just one of the reasons. And so I guess the back of envelope math there right is if eurozone stocks are up 15% but 8% of that is currency, it means 7% of that is something else. It’s other factors. So what else is driving it here?
Absolutely, you’re spot on. There’s a lot that’s in motion at the moment. President Trump is challenging and trying to change what candidly has been the global economic order for the past 80 years, at least since the post-war period. And that’s a very dramatic shift. And I think market participants, investors globally are taking all of that into account.
Fundamentally, what that means is that there’s now more risk in the market. There’s more uncertainty in the market than there was prior to the announcement of all these tariffs. And so what does that mean from an investor perspective?
Well, if you look at European stocks they traded about 13 times earnings. If you look at US stocks prior to the announcement of the tariffs, they were trading at about 21 to 22 times earnings. So in English, what that means for investors is that European stocks are trading at, let’s call it, a 40% discount relative to US stocks.
And so if you’re looking to de-risk your portfolio in light of the fact that the global economic order is being turned on its head, well, one thing that you would naturally want to do is exit more frothy, higher valuation positions and reallocate the portfolio towards lower valuation positions. So pound for pound, dollar for dollar.
Investors, frankly, are getting more assets, more profits, more earnings when they own European stocks at the moment than they are when they own US stocks. And so valuations is a big part of the story.
Another big part of the story is that under the new administration, it’s been clear that US foreign policy is shifting. The president has been very clear that he is less bullish on engagement with NATO. He’s pressed NATO members to increase their defense spending.
And so I think what you’re seeing is a very seismic shift on the continent, in Europe, with respect to regulations, with respect to defense policy. We are going to see a very significant ramp up in defense spending, for example, within the European Union. And that’s going to help drive those aerospace and defense industry stocks in those markets.
When you look at the fact that the Europeans now have been effectively put on notice. I was just listening this morning to an interview with the CEO of Goldman Sachs, and he was even commenting on how bullish he was on deregulation in the European Union.
And this is really the European Union responding now to the fact that they really have to stand on their own two feet from a defense policy perspective, but also from an economic perspective. They’re going to have to deregulate, and they’re going to have to invest more aggressively in growth. All of that is really good news for investors who own non-US equities, especially those European equities.
I saw the CEO of the French mega bank BNP Paribas had said, Europe has no choice but to reinvest right now. And I think that sums up why a lot of these companies, why people, they have to do a lot to catch up to where they want to be. And even though they’re facing some turmoil, they have to put some money into their economies to get through this.
Josh, we are seeing deglobalization in real time. We’re seeing reshoring, friendshoring. And I think the new administration has really just accelerated that particular trend. I think from an investment perspective, that’s going to be a nice tailwind for European investors, especially.
Now taking a step back. There’s been a debate in investing circles over the past number of years, where there have been periods of skepticism about international stocks. There was a stretch there where US stocks outperformed international stocks for a number of years in a row.
And a lot of people said, hey, should we be going all US. That was never the recommendation at Mercer Advisors. And I wondered if you could talk a little bit about why had you always maintained the faith in investing internationally.
Well, you always need to be careful, Josh, chasing stylist returns. And let’s just rewind the tape a little bit. Those of us who’ve been in this business a long time, remember, there was a time from 2000 until the end of 2009. So that was a 10 year period.
And that was a very tumultuous 10 year period globally. We had 9/11. We had the internet bubble. We had the global financial crisis. But if you looked at US stock returns over that 10 year period, they were negative, Josh. They were negative.
So if it was December 31, 2009, and we’re looking back over the past 10 years, and we’re looking at US stocks and non-US stocks and asking ourselves, gee, what should we invest in going forward for the next 10 years. Non-US stocks crushed US stocks over that 10 year period.
And so now if you look at the period from 2010 until 2020 until COVID hit, US stocks did amazingly well. They recovered from the depths of the global financial crisis. Non-US stocks still delivered attractive positive returns. They just didn’t outperform US for that 10 year period.
And so, Josh, I think there’s always danger in looking back over the more recent immediate past, from there, thinking that the next 10 years are going to look like the past 10 years. Investors make this mistake all the time. It’s why many investors, frankly, have very poor returns is because they’re always chasing stylist returns. And so that would be my first comment that you need to be careful chasing stylist returns.
Secondly, one of the reasons that US equities have done so well over the past decade is our technology sector in the United States is quite large.
And so if you compare the size of our technology sector relative to the size of the technology sector in other countries, it’s massive. And that’s really what drove our market higher over the past 10 or 15 years. These other countries just don’t have the same highly developed technology sector that the United States has.
We’ve talked before how it’s those seven companies that was a huge part of it.
Absolutely, like the Magnificent Seven that we saw here over the past several years. And there’s nothing wrong with that. It’s just that as an investor, you need to ask yourself, do you want to be so heavily concentrated in one sector or even just seven companies?
And I think seasoned investors, those that have a lot of gray hair, when you look back year-to-date returns are a very painful reminder around why you don’t want to do that. It’s very difficult to manage your downside exposure when you are not appropriately diversified.
I often tell our advisors and our clients, Josh, that we diversify not because of what we expect will happen, but to protect against what we don’t expect will happen. If everything we expected to happen was going to happen with certainty, then there’d be no reason to diversify, right? There would be no risk. And the reality is that there is always risk, and risk is always impossible to predict.
Look at the tariff announcement on April 2. We all expected the president to put in place tariffs. He campaigned on it. Like I said, we did not expect the severity and the pervasiveness of the tariffs that were announced on April 2.
Are you surprised that European stocks have done so well. Obviously, the European Union is one of the areas that’s potentially going to be hit pretty hard by tariffs.
I don’t think it is a surprise. I think it’s like the next safe haven, right? If you’re a global investor and you are trying to build a diversified portfolio that consists of high quality, relatively safe assets, markets where the rule of law is enforced, where the rule of law is very reliable, I think Europe is a logical next place to land when it comes to including relatively safe haven assets in your portfolio. So that doesn’t surprise me.
For all of its regulations, which I think most of us are seeing a very powerful deregulatory tailwind on the continent at the moment, and I think many of us are bullish on that. If you think that trend is going to continue, and I think it will, the European Investment thesis, I think, really starts to come into focus.
Europeans are going to be, like you said, reinvesting very aggressively, I think, in their own growth and in their own defense going forward. So from an investment perspective, I think all of that is quite attractive.
At the same time, Josh, I think global investors are reassessing the relative safe haven status of the United States. That doesn’t mean that the United States is not a safe haven market. It doesn’t mean that the US dollar will lose its global reserve status. So I just want to be very clear what our listeners. All of this is relative. It’s all relative.
And so I think our standing as a safe haven, reliable market, as a reliable trading partner, frankly, that’s been challenged here over the past 100 days. And I think global investors, rightly so, have to take stock of that. And so I think seeing that shift into European stocks makes a lot of sense, makes a lot of sense. Makes sense for our clients, and it makes sense for investors the world over.
So obviously diversification has worked out really well this year, right? Depending on how much of an allocation you had internationally, you might even be up for the year, whereas someone entirely in the US is down for the year. But stepping back, big picture, what’s the philosophy behind why we think broad international diversification is going to be an important strategy over time?
It really comes back to this concept, Josh, around investing in the entire global economy. Not just cherry picking one or two sectors but really getting broad exposure to the global economy.
The reality remains, Josh, that most of the growth on this planet going forward is not going to come in the United States. It’s not even going to come in Western Europe. It’s going to be in developing markets where they have much higher population growth, lots of innovation, lots of infrastructure building that’s underway.
And so if you had only a US based portfolio, you’re going to miss out on a lot of that growth. And so the whole idea here is to have broader exposure to the global economy, to invest in the entire global economy and not miss out. Now that’s the first point.
The second point, and it goes back to what I said a few moments ago, we diversify to protect our portfolio from the downside, right? Diversification is all about not putting all our eggs in one basket.
It’s about owning lots of different companies, lots of different securities, lots of countries, lots of sectors such that no single country, no single sector, and certainly no single company could sink our client’s balance sheets. That’s why we diversify.
We’re not interested in investing in lottery tickets. We’re looking to build wealth very methodically, very systematically, over time to help families achieve their long term goals. It’s very hard to do that when you’re trying to make bets on individual countries, sectors or companies. And in fact, I would argue that’s not a very responsible way to go about managing long term wealth.
Don, what’s your outlook for the months ahead, and how do we as investors prepare ourselves for the potential of volatility continuing for a little bit of time?
I think we need to remind ourselves that the administration has put a 90-day pause on these tariffs. They did not repeal them. So personally, I think we’re early innings on this whole issue. And so it remains to be seen where the administration is going to land.
So tariffs is part of the equation, but it’s also very likely that the United States is going to slip into a recession and potentially even stagflation here in the second half of this year. In fact, we just got stylist GDP report for Q1 that showed that the US economy actually contracted by 0.3%.
So we’re not technically in a recession yet. The back of the envelope definition is two successive quarters of negative GDP growth. That’s not really the official definition, but that’s the back of the envelope definition, Josh. I think recession is in the cards. I think higher inflation is in the cards. And I think ultimately, those things are going to fuel volatility going forward.
I do think that volatility will probably impact US markets more than non-US markets, but I also think there’s a real possibility here that the administration reverses course. We’ve seen this administration do that time and again. And so I think there’s a very real possibility that they do cut trade deals. And perhaps those trade deals are more lucrative than what we had prior to April 2. Time will tell.
So I think there’s a danger in trying to exit US stocks. I don’t think that’s a very good idea. I think we should remain fully invested, but there’s a possibility that the administration reverses course and the markets could be off to the races again. I think that’s very much in the cards.
I do think that the damage from tariffs has already been done. If you actually look at some of the data, look at the activity at US ports, if you look at container ships in terms of how full they are coming into the United States, all of that is already going to negatively impact the US economy.
So I’m expecting a recession here over the middle of this year. I’m also expecting inflation for the remainder of the year. So I think those things are going to lead to some volatility.
What do investors do with all that, Josh? They should remain very well diversified. They should make sure that they have a financial plan in place. They should make sure that they have sufficient liquidity in place and discuss with their advisors whether or not there’s any positioning across the balance sheet that they may want to consider, given the short and near term prospects.
It’s sometimes been the case, maybe even often been the case, that the market starts to rebound before the economy does anyway. So we should be very humble predicting when that turning point is going to be in.
Remember, markets are forward-looking. Economic data, by definition, is always backward-looking.
And so there’s a saying on Wall Street that the stock market has predicted 12 of the last three recessions. And so there’s some truth to that. So you want to be careful. I totally agree.
I mean, typically markets recover anywhere from three to six months before there’s evidence that the economy is beginning to recover. So again, I think trying to time the market based on a recession is a very, very bad idea.
Don, thanks so much for being here today for this conversation.
It’s great to be here, Josh. Thank you.
If you’re already a Mercer Advisors client, don’t hesitate to reach out to your advisor to talk about how you’re positioned right now. If you’re not Mercer advisors client, but you’re interested in more information, check out our website Merceradvisors.com. It always starts with the phone call. Thanks so much for being here with us today. This has been Market Perspectives.
[MUSIC PLAYING]
PLAYING]
