With that in mind, investors’ fears over international risks are presenting an attractive opportunity for advisors to add value by providing a steady hand in maintaining diversified portfolios that include appropriate allocations to non-U.S. stocks.
On one hand, it’s understandable that investors are anxious about international equities. The Ukraine conflict is likely to entice countries to continue economic sanctions against Russia, which is already suffering from a weak economy. Atrocities by the radical Muslim group ISIS, meanwhile, are calling attention to the organization’s spreading and destabilizing influence in the Middle East.
As if those concerns aren’t enough, investors are also pondering the outcome of negotiations to halt Iran’s development of nuclear weapons. A global glut of oil prices, meanwhile, has caused pricing of the commodity to drop more than 60% since the middle of 2014. That could wreak havoc with countries that depend on oil exports but can’t produce the commodity as cheaply as members of the Organization of the Petroleum Exporting Countries that are seeking to capture market share. Many countries furthermore, are struggling with declining currency values, which of course can cut into the returns of foreign equities.
Yet, advisors and their clients shouldn’t dismiss the merits of international investing. Non-U.S. equities continue to be a powerful asset class for portfolio diversification while large-scale trends may help the stocks generate attractive returns.
One way to look at many foreign countries is that they are in a position, economically speaking, that is similar to the U.S. three or four years ago. Indeed, Japan and the eurozone are embarking on quantitative easing, or the practice of printing money to make large-scale purchases of securities.
The goal is to keep interest rates low while injecting cash into the economy. For the U.S., of course, quantitative easing accomplished those goals and was wound down last year, although the impact of the practice is still being felt as the Federal Reserve will hold debt securities until they mature.
The benefits of quantitative easing, however, aren’t limited to keeping interest rates low. Indeed, the printing of money combined with other stimulus from central banks and sluggish economic conditions often causes countries’ currencies to decline in value relative to other countries. While the decline in currencies can eat into equity returns when the value of stocks is converted into U.S. dollars, it can also help foreign countries boost their revenues.
That’s because the weaker currencies will make countries’ exports more affordable, thereby driving an increase in product sales. While that can support earnings, it can also stimulate local economies by providing increased demand for workers. Indeed, Japan and Europe may potentially benefit from weaker currencies. The strength of the U.S. dollar, meanwhile, will make imports to those countries more expensive, so residents of Japan and Europe may be more likely to buy locally made products, which would provide additional economic support. Germany, for one, appears to be an early beneficiary of this trend with its manufacturing sector showing considerable strength.
Many central banks in foreign countries, meanwhile, are providing traditional forms of stimulus, including maintaining low interest rates. The European Central Bank, for example, has actually established negative short-term rates to boost the economy.
Lower oil prices, while being detrimental to countries that export energy commodities, are likely to support economic growth in countries that rely heavily on importing petroleum products. For consumers in such countries, lower oil prices will be comparable to receiving a tax break—that is, the lower prices will increase consumers’ spending power. At the same time, lower energy costs should help improve corporations’ earnings.
When working with clients, advisors should be able to explain the above described considerations for international investing and emphasize that investing abroad is a long-term endeavor. The asset class may not immediately produce attractive returns, but nevertheless it offers potential for generating attractive gains over the long term.
Advisors should also be prepared to illustrate how an allocation to international investing can help dampen portfolio volatility by improving diversification. The benefits of economic stimulus and lower energy prices, of course, won’t be spread evenly among non-U.S. countries, so the use of active managers who can assess the risk and return characteristics of different markets may be appropriate.