The Weak Dollar Puffs Up Overseas Equity Returns


April 18, 2018 [U.S. Dollar, Emerging Markets, Developing markets]
Josh Rubin

Yet the earnings potential of developed and emerging markets stocks is real, since they are at earlier points in their respective business cycles.

Fundamental indicators continue to show broad health in economies and most companies around the world. But adjusting for currency effects in equity market returns adds perspective on relative valuations and especially where we are in the business cycle of different regions across the world.

In U.S. dollar terms, it appears that U.S., international developed (MSCI EAFE Index) and emerging markets (MSCI EM Index) are all moving modestly higher this year (through April 18). But if we exclude the translation effect of the weakening dollar, when considered in local currency terms international developed markets are performing materially worse than the U.S. or even a flat emerging market.


  Equity Market Total Returns in US Dollars 1Q18 April 1–18 YTD
  U.S. (MSCI USA Index) -0.6% +5.2% +2.3%
  International Developed Markets (MSCI EAFE Index) -1.4% +3.2% +1.7%
  Emerging Markets (MSCI EM Index) +1.4% +0.7% +2.0%
  Equity Market Total Returns in Local Currency 1Q18 April 1–18 YTD
  U.S. (MSCI USA Index) -0.6% +5.2% +2.3%
  International Developed Markets (MSCI EAFE Index) -4.3% +1.9% -3.1%
  Emerging Markets (MSCI EM Index) +0.7% +0.0% +0.3%

One takeaway is that, so far, there’s been much ado about nothing. As markets have gyrated, economic momentum and the outlook for corporate fundamentals appear mostly unchanged. After a lot of drama in the first 108 days of the year, the benchmark indices aren’t far from where they started, and the world is still chugging along. A key to success in any fundamentally oriented investment strategy is to focus on the durability of corporate fundamentals as well as the fundamental backdrop of the markets in which stock and bond issuers operate, while being aware of—but not swayed by—stock and bond market skittishness.

In this context, it may be disappointing—but not particularly surprising—to see that over a short measurement period, the MSCI EAFE Index has underperformed the rest of the world. In fact, in local currency terms, over the last nine months the EAFE's degree of relative underperformance against the MSCI World Index has been the worst since 2003. Although developing market equities haven’t kept pace with other regions, strengthening foreign currencies have neutralized the softer local currency returns for U.S.-based investors.

At the same time, the MSCI EAFE Index (and especially Europe, which is the largest component of the EAFE) has exhibited a notable improvement in earnings over the last 18 months. More to the point, while U.S. equities surpassed peak earnings long ago, index earning for developed markets and emerging markets still have room to run before they hit prior peak levels.

If earnings ultimately drive equity-market returns, developed and emerging markets remain attractive alternatives to the U.S., even in dollar terms, as indicated in the graphic below.



Source: Bloomberg, blended forwards 12-month estimates as of April 18, 2018.


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