The US Dollar index versus a basket of foreign currencies rose 28% from the start of 2021 to a peak in September 2022. This move was driven by the US Federal Reserve’s decision to raise interest rates and shrink its balance sheet, which had ballooned during the Covid pandemic. In some cases, the Fed moved before their overseas counterparts did. The result was a rising currency supported by high US Treasury yields. The stronger dollar caused some international markets to underperform in US dollar terms, particularly those with currencies with strong inverse dollar relationships.
US Dollar Index – Weekly
US Dollar Index – Monthly
Currently, bond market futures are predicting that the Fed will end its tightening cycle this year. As a result, the US dollar has been declining for the last several months. This is making some international equity markets more attractive for US-based investors.
Developed Markets: Europe and Japan
Europe and Japan have long been major laggard markets versus the US market. We look at foreign markets in USD terms to keep a consistent relative view over time. The change in the USD’s trend may represent a significant inflection point in both European and Japanese equity markets for US dollar-based investors.
The iShares Europe ETF (IEV), which tracks the S&P Europe 350 Index, is up just 37% from its introduction in mid-2000 (see monthly chart below). This compares with a 185% gain for the S&P 500. It last had a multi-year relative upside move versus the S&P 500 from March 2003 to October 2007, when it outperformed +175% to +75% over the 4.5-year period. Since its October 2007 peak, it is down 16% versus a 167% gain for the S&P 500. This is a tremendous gap and we believe some reversion is likely to occur. We believe a weak USD could be a major tailwind for US investors interested in Europe – especially if the EU can avoid a recession. We also believe the valuation of European markets is very attractive historically compared to the US. Currently the gap between valuation of EU stocks vs. their US peers is at a 30-year high, with the Stoxx 600 trading at 13x PE forward vs. S&P 500 trading at 19x (using adjusted PE positive). In addition, the Stoxx 600 also offers a higher dividend profile i.e., trading at a ~3.5% 2023 dividend yield and 8% FCF yield. Lastly, large-cap European stocks are more exposed to international markets than their US peers. For example, we believe that the reopening of the Chinese economy should be an important driver for European markets. We recognize, however, that such a bullish scenario will likely depend on the macroeconomic environment. While China reopening is clearly bullish for European equities, a majority of strategists expect the PMI to start deteriorating. All of that is to say that this earning season will be key and likely to drive the index in one direction or another. Across various countries in the region we like Consumer Staple, Consumer Cyclical (autos, apparel), and Capital Equipment. Financials are also acting much better overall here than in the US.
iShares Europe ETF (IEV) – Monthly
Some US ADRs from Europe that are worth considering include cosmetics maker L’Oreal (LRLCY), luxury goods maker LVMH (LMVUY), auto makers Ferrari (RACE) and BMW (BMWYY), alcohol maker Pernod Ricard (PRNDY), and Danske Bank (DNKEY), diversified industrial Siemens (SIEGY), mining equipment maker Atlas Copco (ATLKY), insurance provider Munchener Reuckver (MURGY), wind/solar developer Iberdrola (IBDRY), gaming products developer Evolution (EVVTY), drug maker AstraZeneca (AZN), and food retailer Compass Group (CMPGY).
The iShares Japan ETF (EWJ), which tracks the MSCI Japan Index, is down 2% since its introduction in 1996 (see monthly chart below). This is versus a roughly 560% gain for the S&P 500. Its last multi-year outperformance of the S&P 500 was from January 2001 to April 2006, when it gained 130% versus a 35% gain for the S&P 500. Since the April 2006 peak, it has been down 5% versus a 216% gain for the S&P 500. Japan seems particularly timely for reversion. It is interesting that Warren Buffet recently visited Japan and his company Berkshire Hathaway has invested in five Japanese trading houses. We would encourage investors to look at this equity market. The weak USD is a major tailwind for US investors. Notably, the large Japanese multinational stocks are generally cheap and aided by some signs of strength including in capital spending (+7.4% y/y in Q4 2022) and recent export growth (+4.3% y/y in March 2023 after +6.5% y/y in February 2023). The focus on outward foreign investment is beneficial if the global economy is strong. The risk here is a trade war with China or a global slowdown. Other headwinds include still sluggish overall growth (GDP flat q/q in Q4, below estimates), labor shortages, long-term stagnation in wages (+4% nominal growth from 1990-2019, -2.6% real wage growth y/y in February 2023), undesired type of recent inflation (import cost driven, instead of by demand strength), persistent government debt/ Japanese GDP of well over 200%, and the potential for pressure on deficit spending if higher interest rates occur. We like Japanese Capital Equipment (Diversified, Machinery, etc.), Health Care, and Consumer Staple sectors.
iShares Japan ETF (EWJ) – Monthly
A handful of US ADRs from Japan that are worth considering include diversified industrials Hitachi (HTHIY), Itochu (ITOCY), and Mitsui (MITSY), electronic maker Sony (SONY), cosmetic provider Unicharm (UNICY), money center bank Sumitomo Mitsui Financial (SMFG), medical device manufacturer Hoya (HOCPY), apparel maker Fast Retailing (FRCOY), and network systems developer Fujitsu (FJTSY).
Emerging Markets: India and Mexico
India, with its growing population and rising per capita incomes, represents one of the best national secular growth stories in the world. Strong economic fundamentals, highlighted by GDP growth of at least 4% annually in all but six of past 35 years, 6-7% expected GDP growth in 2022-23 and 2023-24, and longer-term expected annual GDP growth of ~6% expected through 2030. India is now the most populus country in the world. It is on pace to be world’s third largest economy by 2030, from fifth currently and 11th a decade ago. Mega-trends including a younger demographic, rising median incomes, rising productivity, huge infrastructure spending (~$1.8T over next five years), urbanization, decarbonization, and digitization as well as a major global supply chain shift from China. Headwinds for the country include rising costs, lulls in consumption, still restrictive foreign investments in some areas, and high-equity valuations. The domestic BSE 30 Sensex Index has been an excellent relative performer over the very long term. Since 1995 it has been up 1,400% versus an 800% gain for the S&P 500. Much of the outperformance came from 2000-2010. From March-2010 through March-2020, it underperformed the S&P 500 by about 50%. However, since March 2020 it has led the S&P 500 by around 40%. Over time, currency depreciation has eaten away at the gains. Since 1995, the rupee has lost over 60% versus the USD and since 2010 it has lost about 45%. But, most recently it has been a bit more stable, down just 6% since 2020 and slightly positive in 2023. The iShares MSCI India ETF (INDA), which tracks the MSCI India Index, has lagged heavily to start 2023 but is beginning to show signs of life. It is above its 10-week moving average (WMA) and has picked up a bit of relative performance over the last five weeks. While more work is needed to improve the technical picture, including a retake of the 40-WMA (-2%), our confidence is rising in this dynamic market. Favorable sectors include Financial, Health Care, Consumer Staple, and Capital Equipment.
iShares MSCI India ETF (INDA) – Weekly
A handful of US ADRs from India which are worth considering include outsourcing service provider WNS (WNS), money center banks HDFC (HDB), and ICICI Bank (IBN), and drug manufacturer Dr. Reddy Labs (RDY).
Like India, Mexico has strong economic internals and is benefiting from rising foreign investment. This is particularly true as many companies in the US shift production from China to Mexico. As a result, the macro-outlook in Mexico is favorable in 2023. The IMF has revised upward its growth forecast for Mexico’s GDP in 2023 to 1.8%, up from the 1.7% estimated in January. The forecast for 2024 remains unchanged at 1.6%. The Mexican government has a more optimistic growth forecast of 3% for both 2023 and 2024. Regarding interest rates, the Bank of Mexico’s governing board unanimously voted to hike the benchmark interest rate by 25 basis points to 11.25% at its April meeting, moderating the pace of its tightening cycle. Expectations for the end of the rate hike cycle are supported by slowing inflation. In the first half of April, consumer prices reached their lowest level in a year and a half. Annual headline inflation through mid-April reached 6.2%, the lowest since the first half of October 2021, when the rate was 6.1%. In O’Neil Methodology terminology, the Mexican equity market is in an Uptrend. As such, we think Mexican stocks are attractive and would focus on sectors such as Financial, Basic Material, and Consumer Staple, which stand to benefit from a more favorable macro environment.
iShares MSCI Mexico (EWW) – Monthly
US ADRs from India worth considering include cement maker Cemex (CX), Coca-Cola bottler FEMSA (FMX), cosmetics provider Kimberly Clark Mexico (KCDMY), and airport operator Grupo Aeroportuario (ASR).
In conclusion, the recent weakness in the US Dollar may offer US investors an opportunity to invest in foreign markets that benefit from the dollar’s decline, specifically Europe, Japan, and Mexico. We also favor India given it is the fastest growing major economy in the world. At a minimum, overseas markets offer domestic investors diversification benefits. In addition, given the amount many of these markets have lagged the US, we believe some continued performance reversion is likely and favor the current technical setups compared with the S&P 500.
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