The pace of economic recovery outside the U.S.
The coronavirus has impacted different countries with differing severity at different times, so it stands to reason the economic recovery will move forward in different ways as well.
To be fair, gross domestic product (GDP) numbers have been generally awful everywhere, from China to Germany and most places in between. But that’s what’s behind us; what’s ahead appears to be an uneven recovery, with some countries returning to growth faster than others. Germany, for example, reported a record quarter-over-quarter drop in GDP of 10.1% in 2Q but, as The Wall Street Journal reported, “A host of recent indicators suggest that the German economy is staging a sharp V-shaped recovery, bolstered by aggressive state-support schemes for workers and businesses.”1 As Germany goes, so goes much of Europe.
For its part, China saw a year-over-year increase of 3.2% in 2Q GDP, slow by historical standards but moving in the right direction. In Japan, the economy shrank by 2.2% on an annualized basis in 1Q. While in the U.S., GDP declined by an unprecedented 32.9% annualized rate last quarter.
In response, the U.S. Federal Reserve has held interest rates near zero. This, in combination with massive fiscal spending, has provided support for the economy but has likely contributed to weakness in the dollar. The Wall Street Journal Dollar Index, a weighted measure of 16 currencies, started the year at 96.50, rose to 102.75 in the early stages of the pandemic, and has since fallen steadily to a recent close of 93.45. It has been volatile during this period, but mostly trending downward.
Around the world we have seen a wide divergence in the response to the spread of the coronavirus, from Brazil’s laissez faire policies to draconian lockdowns in China. Other countries – France, Germany, England, and Sweden, to name four – fall somewhere along that continuum. Some adopted more stringent policies earlier in the crisis, and have been more successful in both containing the virus and reopening. While these initiatives will be imperfectly correlated to economic performance, they will have an impact, particularly on consumer spending, which feeds directly into GDP. The faster the virus is contained, the faster people can start moving around again and economies can return to something like normality.
All these factors – an uneven global recovery, varying responses to Covid-19, and a volatile, but generally weakening dollar – again argue the case for U.S. investor exposure to international stocks.
Valuations provide further support. S&P 500 companies are trading at $26 per dollar of next 12 months earnings. The comparable number for international developed stocks, as represented by the MSCI EAFE, is $20.80. This in spite of the fact that EAFE (Europe, Australasia and Far East) economies look set to outperform the U.S.
Following a disastrous first half of the year, analysts expect global economic growth to accelerate in the second half, fueled in large part by fiscal support, but the growth is likely to be uneven. This should be of particular benefit to the more cyclical sectors. International markets tend to be more manufacturing-based and export-driven, positioning them to outperform in any cyclical upswing.
For investors looking to gain exposure to non-US markets, a broad-based international Exchange Traded Fund (ETF) can provide diversification across global economies. In the case of the IQ 50 Percent Hedged FTSE International ETF (HFXI), the underlying index includes exposure to primarily large- and mid-cap companies across 24 developed markets and is float-adjusted and market-capitalization weighted. Equally important, it uses a 50% currency hedge, providing a cushion against dramatic currency moves without requiring investors to commit to a point of view on the direction of the dollar.
The coronavirus has again highlighted the fact that regional and local economic and political policies matter, and can lead to a divergence in economic growth even among the developed nations. International diversification provides a way to capture the opportunities inherent in this divergence.
- Wall Street Journal; July 30, 2020
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The Wall Street Journal Dollar Index (WSJ Dollar Index) is an index (or measure) of the value of the U.S. dollar relative to 16 foreign currencies. The index is weighted using data provided by the Bank for International Settlements (BIS) on total foreign exchange (FX) trading volume. The index rises when the U.S. dollar gains value against the other currencies, and falls when the U.S. dollar loses value against the currencies.
The S&P 500® Index is widely regarded as the standard index for measuring large-cap U.S. stock market performance.
The MSCI EAFE® Index consists of international stocks representing the developed world outside of North America. The EAFE acronym stands for Europe, Australasia and Far East.
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