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Investment Strategy

February 06, 2023

Helmet-to-Helmet on Domestic vs. International Equities

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Below is a transcript of this week’s video:

After years of underperformance, there is justified skepticism of the value of international exposure in a diversified portfolio. However, Glenmede’s research has shown that an optimal long-term equity portfolio should comprise roughly 20-30% of international equity issues, as investment in foreign markets is crucial for diversification purposes to improve the longer-term balance of risk and reward shown by this efficient frontier.

In recent years, the U.S. equity market has largely outperformed its international counterparts, leading some to question international’s place in portfolios. Yet, if we look at the longer-term picture, it appears a bit more balanced. Foreign versus domestic stock leadership tends to go through multiyear cycles, and the period from 2002 to 2009 saw international equities outperform for eight out of nine calendar years, and by a meaningful margin. Given this behavior and the last decade’s outperformance of U.S. stocks and outperformance by international stocks at the end of last year, investors should consider the possibility that another run of foreign leadership is a possibility.

From a valuation perspective, using Glenmede’s long-term valuation ranges, U.S. markets remain more richly valued relative to their international counterparts, particularly looking at Japan that’s trading at a discount and emerging markets valuations sitting just a hair above fair value. From an earnings perspective, aside from Europe, foreign equities are actually expected by analysts to offer more attractive earnings growth in 2023 as well, at this point in time.

If we take stock of the economic picture overseas, in general terms, it is turning out to be less bad than initially feared, as China has accelerated their reopening and Europe’s milder winter has softened the impact of energy shortages in the region.

Further, the recent dollar weakness has provided support as well, as the dollar has decline from its second standard deviation high. If we look at annualized equity performance from 1973 for either the full period or periods during a weakening dollar, we see that international equities* have posted an annualized 35.3% return during months of a weakening dollar since 1973 compared to 17.6% for the S&P 500.

We look at the current central bank policy rates from a handful of major developed economies compared to the expected level of those central bank policy rates by the end of 2023. Those estimates are derived from futures and swaps markets, where investors are essentially placing live bets on where they think policy rates are heading. In the U.S., markets are pricing in Fed cuts by year-end, while foreign central banks are expected to continue raising rates, which will likely serve as a headwind for the dollar here on a go-forward basis, further supporting the case for international equities.

To summarize, a well-diversified portfolio of equities should contain roughly 20-30% international exposure for diversification purposes because international markets tend to go through multiyear cycles of under- and outperformance relative to domestic markets. Many international markets trade at a relative discount to their domestic counterparts at this point in time. The economic picture overseas is turning out to be less bad than feared, and some of the better earnings trends may be found abroad as well. A weakening in the U.S. dollar may be a tailwind to international equities, which may continue if foreign central banks tighten more than the Fed.

*As represented by the MSCI All Country World ex-U.S. Index, backfilled by the MSCI EAFE Index


This material is intended to review matters of possible interest to Glenmede Trust Company clients and friends and is not intended as personalized investment advice. When provided to a client, advice is based on the client’s unique circumstances and may differ substantially from any general recommendations, suggestions or other considerations included in this material. Any opinions, recommendations, expectations or projections herein are based on information available at the time of publication and may change thereafter. Information obtained from third-party sources is assumed to be reliable but may not be independently verified, and the accuracy thereof is not guaranteed. Outcomes (including performance) may differ materially from any expectations and projections noted herein due to various risks and uncertainties. Any reference to risk management or risk control does not imply that risk can be eliminated. All investments have risk. Clients are encouraged to discuss any matter discussed herein with their Glenmede representative.