International Equities at a Crossroads

Kristian Kerr (00:04):

One of the most prominent trends in equity markets this year, at least so far, has been the steady rotation to international equities. Year-to-date the MSCI World ex-U.S. Index, a widely used benchmark that tracks equity market performance outside the United States, has delivered a return of 9%. In contrast, the S&P 500 has experienced a decline of almost 2% over the same period. This pronounced outperformance of international equities has largely been driven by strength in European and Chinese stock markets. In China, advances in artificial intelligence coupled with policy easing measures have bolstered investor confidence leading to increased foreign investment in Chinese equities. Meanwhile, European equities have benefited from improving economic growth expectations, catalyzed in part by a historic shift in German fiscal policy. Both regions also began the year with tragically discounted valuations, which likely provided an additional incentive for investors looking to diversify their portfolios.

Kristian Kerr (00:57):

Now, looking ahead, assessing whether this rotation in international equities is sustainable will be a central focus for the equity markets as we move into the second quarter. Currently, foreign investors are estimated to hold up to 30% of the total U.S. equity market. Should these investors opt to reallocate more sizable portions of their holdings back into domestic equity markets, the resulting flow of fund impact could be meaningful. This is particularly relevant given the disparities and market liquidity between the U.S. and other regions. For example, by some estimates, the liquidity of U.S. equity markets is at least 11 times greater than that of Europe. As a result, a larger patriation of funds to less liquid international markets could lead to amplified effects on the performance of foreign indices. In an extreme case, this could even result in price movements that exceed what would be justified by fundamental valuations.

Kristian Kerr (01:43):

However, it's worth noting that international equity indices have already seen substantial gains within a relatively short time span. Many of the positive catalysts that drove their outperformance in the first quarter may now be fully reflected in current pricing, leaving less room for additional upside unless new developments emerge to further support the case for international markets. If international equities fail to garner new positive catalysts in the coming months, the focus may shift back to more structural factors that influence global equity markets. In this scenario, U.S. equities could regain their dominance as they historically have demonstrated stronger fundamental advantage over their international counterparts. Notably, U.S. companies have consistently grown their profit margins over time. This steady margin expansion supports robust earnings and productivity growth in the U.S., Which will likely remain more favorable compared to what Europe or EM can offer. These inherent strengths almost always make U.S. equities an attractive destination for international capital seeking reliable long-term returns.

Kristian Kerr (02:37):

Another critical factor to consider is the trajectory of the U.S. dollar. Historically, a significant weakening of the dollar has been closely linked to the outperformance of international equities. A weaker dollar serves as a tailwind for foreign equity markets, encouraging capital flows away from the U.S. into international. However, while the dollar has shown modest signs of weakening during the first quarter of 2025, its movement remains largely range bound. There is no concrete evidence, at least yet, of a more pronounced downtrend that will be required to trigger substantial reallocation of capital towards international equities. Without a definitive downward shift in the dollar's value the ability of international markets to sustain their outperformance may be limited. In the absence of fresh catalyst and amid structural considerations and currency dynamics, investors may find themselves reevaluating the sustainability of recent trends favoring international equities. These dynamics highlight the ongoing interplay between short-term drivers and long-term forces, which will shape market performance on the international question as the year progresses. As we approach what should be an important inflection point for international equities in the second quarter, our positioning remains unchanged. We are overweight on the U.S., underweight on emerging markets, and maintain a neutral stance on developed markets. Moving forward, we'll continue to closely monitor the dollar, economic data, earnings forecasts, and various other quantitative metrics to determine if adjustments to our outlook are necessary. Thank you for your time today and I wish you a highly successful and prosperous second quarter ahead.