It May Be Time to Consider Non-U.S. Equities
- We believe that stretched relative valuations and potential U.S. dollar weakness have created attractive diversification opportunities in non‑U.S. equities.
- Investors seeking to maintain their current exposure to technology may want to consider tilting their non‑U.S. equity allocations toward the emerging markets.
U.S. stocks have outperformed non‑U.S. equities over the past 12 years, stretching relative valuations. Compared with both developed and emerging markets (EMs), valuation premiums1 on U.S. stocks currently are twice as high as their 20‑year averages.
There are numerous reasons for this divergence, but we would highlight two in particular: U.S. dollar strength and the dominance of technology in U.S. equity benchmarks.
Historically, periods of sustained U.S. dollar strength have coincided with U.S. equity outperformance. So it is notable that the dollar recently has weakened significantly. The Intercontinental Exchange (ICE) U.S. Dollar Index fell almost 10% over the six months ended August 31, 2020.
A Picture Emerges in Non‑U.S. Stocks
U.S. dollar weakness and higher technology exposure could favor EM equities
Past performance is not a reliable indicator of future performance.
January 31, 1991, through September 21, 2020 (left chart). As of September 21, 2020 (right chart).
Sources: Russell, MSCI, and ICE (See Additional Disclosures). T. Rowe Price calculations using data from FactSet Research Systems Inc. All rights reserved.
We believe dollar weakness could continue, as interest rate differentials and economic growth expectations between the U.S. and the rest of the world both have narrowed. Technology dominance is a different story, however. The drivers of technology outperformance have been strengthened by the global pandemic, and we believe they are unlikely to fade soon.
As of September 21, 2020, technology, interactive media, and internet retail combined accounted for less than 10% of the Morgan Stanley Capital International Europe, Australasia, and the Far East Index (MSCI EAFE). The MSCI Emerging Markets Index, however, had higher technology exposure than the MSCI USA Index.
We believe investors may be able to take advantage of potential dollar weakness while maintaining exposure to technology by potentially tilting their non‑U.S. equity allocations toward emerging markets.
1 A valuation premium is the higher price that an investor is willing to pay for a given stock or group of stocks relative to other stocks with comparable fundamentals such as earnings or sales.
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Past performance is not a reliable indicator of future performance. All investments are subject to market risk, including the possible loss of principal. Diversification cannot assure a profit or protect against loss in a declining market. International investments can be riskier than U.S. investments due to the adverse effects of currency exchange rates, differences in market structure and liquidity, as well as specific country, regional, and economic developments. These risks are generally greater for investments in emerging markets. Investing in technology stocks entails specific risks, including the potential for wide variations in performance and usually wide price swings, up and down. Technology companies can be affected by, among other things, intense competition, government regulation, earnings disappointments, dependency on patent protection and rapid obsolescence of products and services due to technological innovations or changing consumer preferences. All charts and tables are shown for illustrative purposes only.
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