Why To Look For Opportunities Overseas [Vanguard FTSE Europe ETF, iShares MSCI Emerging Markets Indx (ETF)]

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May 28, 2015 3:49pm NYSE:EEM NYSE:VGK

opportunityThough U.S. equities can continue to climb this year, Russ explains why he believes the best stock market opportunities may still reside abroad.

Why to Look for Opportunities Overseas

U.S stocks ended last week essentially flat, although the S&P 500 Index did post another record close on Thursday. While I believe U.S. equities can continue to climb and post further gains before the end of the year, the best opportunities may still reside outside the United States. As I write in my new weekly commentary, “Tantrum Potential at Home, Opportunity Overseas,” U.S. stocks have clearly benefited from the Federal Reserve (Fed)’s languid path to an initial rate hike. However, the market’s luck may not last. A fall rate hike is likely, particularly after April’s consumer inflation report showed core inflation (which excludes food and energy) accelerated on the back of higher medical and rent costs.

Though an autumn rate hike by the Fed is unlikely to be a catastrophe for U.S. stocks, it would mean that the safety blanket of ultra-accommodative monetary policy starts to be removed. And as the market demonstrated in the spring of 2013, investors’ reaction to losing their safety blanket is roughly the same as most toddlers: a tantrum may, at least temporarily, ensue.

In contrast, most other countries can look forward to at least another year, maybe longer, of monetary accommodation, good news for international stocks.

In Europe, recent comments suggest the European Central Bank (ECB) may front load its program of bond buying. This news helped to weaken the euro, and a softer euro, a dovish central bank and lower German Bund yields helped push European equities up by nearly 3% (in euros) last week.

Japan offers a similar story, with the Bank of Japan committed to 80 trillion yen/year of asset purchases. This massive program has helped to push the yen down relative to the dollar. A weaker currency, paired with a significant surge in share buybacks, has allowed for strong earnings growth. Indeed, 30% of companies listed on the first section of the Tokyo Exchange reported record profits for the year, the largest percentage since 2006. Strong earnings growth, not multiple expansion, has been the key driver of the Japanese stock market, which last week rose to its highest level since 2007. The TOPIX Index is now up roughly 17% (in yen) year-to-date.

Even emerging markets (EMs), long the laggards of the global equity market, are turning. China has dominated the headlines and investor focus, but Korea, Poland, Hungary and Russia have also posted double-digit gains this year. The turnaround in EM performance has been accompanied by a reversal of fund flows. Last week, EM equity exchange traded funds garnered $1.2 billion in investor assets, according to BlackRock data.

To be sure, lingering issues remain in international markets. Chinese equities have skyrocketed on the back of speculative buying locally and easy money policies. In Europe, Greece is a lingering problem and time is running out.

Still, lower valuations and monetary accommodation suggest investors should consider raising their allocation to non-U.S. equities. And as they do, U.S. investors should preferably gain that exposure via instruments that seek to hedge the foreign currency impact, as dollar strength means equity gains in local currency terms will be muted when translated back into U.S. dollars.

Sources: Bloomberg, BlackRock

Russ Koesterich, CFA, is the Chief Investment Strategist for BlackRock. He is a regular contributor to The Blog.

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