What Could Go Right in International Stocks

What Could Go Right in International Stocks

Concerns about economic growth and geopolitical risks have weighed on international markets, but a softening of U.S.-China trade rhetoric and weakening dollar could spark a new wave of outperformance.

Growth Drivers Across Regions

Currency headwinds from a strengthening U.S. dollar (USD) and a moderate slowing of growth have weighed on international equities in 2018. The escalation of global trade tensions, meanwhile, have hurt investor sentiment, causing weaker flows to non-U.S. equities and leaving the asset class in what we consider an oversold position.

However, negative headlines are underestimating the many positive drivers supportive of companies in developed markets. Economic fundamentals are solid, beginning with the consumer. Wages are rising in many countries where we are invested, unemployment is at low levels, consumer balance sheets have improved materially and confidence is near historic highs. Although unemployment is a lagging indicator, we could see eurozone unemployment fall to 7% in 2020 (from 8.3% currently), which would be the lowest level since before the global financial crisis. Japanese unemployment is around 30-year lows, causing more women to enter the workforce to fill jobs.

The corporate picture is also encouraging. Global Purchasing Manager Index (PMI) levels remain well above 50, indicating healthy industrial activity. Capacity utilization rates are around 84%, a level which normally leads to more capex investments; it’s simply a question of when the spending will commence.

Corporate balance sheets in Europe are strong while Japanese companies are flush with cash. But the strong level of cash flows for international companies have not been deployed into share buybacks as much as we have seen in the U.S., so buybacks could be another potential tailwind in Europe and Japan.

While the U.S. is well into its interest rate tightening cycle, central banks in Europe and Asia remain mostly accommodative. We expect the European Central Bank will maintain QE through the end of this year, be neutral in 2019 and not commence rate hikes until 2020. The Bank of Japan is expected to keep rates close to zero to stimulate inflation.

The big wild card here is China. After beginning a program of deleveraging that caused growth to slow, the Chinese central bank has opened up the money supply through their reserve requirement ratios for the banks and is starting to pump money into the economy. We saw that particularly in July. Now the question is: are the banks likely to lend that money out? We think the answer is yes.


China's Money Supply is Increasing (China M2 Money Supply, 12/30/16 to July 31, 2018)


Source: Bloomberg. M2 money supply represents an economy's total cash, checking and saving deposits, money market securities and other highly liquid financial instruments.  Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

Valuations remain compelling in the international markets we monitor, and we could see multiple expansion from here. P/E multiples normally do not de-rate if earnings are growing and earnings in Europe, for example, remain 18% below their 2008 peak. Southern Europe, in particular, is lagging and has room for improvement. Over the next several years, earnings growth in emerging markets should be slightly better than the U.S., while the eurozone should see growth similar to the U.S. as tax reform benefits there recede.

Risks That We're Monitoring

Trade war and tariffs are counterproductive for global markets. Tariffs will hurt economic growth and could spark inflation and higher interest rates. To deal with tariffs, companies will need to alter their supply chains, which is time consuming and leads to higher costs. Once they do so, it is very difficult to bring them back quickly. We expect to see more companies complaining about the trade war and the impact on their businesses. We are watching the tone of trade rhetoric as we near the midterm U.S. election and hoping for a reversal or easing of the current pressure being applied by the U.S.

Italy is a hotspot right now due to political uncertainty. We view it as a bigger potential risk than even Brexit because Italy is a large economy (15% of eurozone GDP and 23% of public debt) and the last one in Europe to take measures to improve growth. The Italian election in May resulted in a compromised candidate, Prime Minister Giuseppe Conte, and two vice prime ministers from anti-establishment parties. The political situation creates uncertainty and will likely postpone business and consumer spending, which will hurt GDP growth. The new government also must present a new budget by October and it will likely cause debt levels to rise again, bringing Italy in conflict with the EU. We expect a lot of negative headlines coming out of Italy in the next month but overall, the government will find a way to manage. We believe most Italians still want the euro and to remain part of the EU.

What happens on the trade front will have the most immediate impact on international equities. If the trade rhetoric eases, the USD should weaken and emerging markets should benefit. This could provide a pathway to the next wave of performance in international markets.


Important Information


All investments involve risk, including possible loss of principal.

The value of investments and the income from them can go down as well as up and investors may not get back the amounts originally invested, and can be affected by changes in interest rates, in exchange rates, general market conditions, political, social and economic developments and other variable factors. Investment involves risks including but not limited to, possible delays in payments and loss of income or capital. Neither Legg Mason nor any of its affiliates guarantees any rate of return or the return of capital invested. 

Equity securities are subject to price fluctuation and possible loss of principal. Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls.

International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.

Commodities and currencies contain heightened risk that include market, political, regulatory, and natural conditions and may not be suitable for all investors.

Past performance is no guarantee of future results.  Please note that an investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges.

The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, guarantee of future results, recommendations or advice.  Statements made in this material are not intended as buy or sell recommendations of any securities. Forward-looking statements are subject to uncertainties that could cause actual developments and results to differ materially from the expectations expressed. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed. Information and opinions expressed by either Legg Mason or its affiliates are current as at the date indicated, are subject to change without notice, and do not take into account the particular investment objectives, financial situation or needs of individual investors.

The information in this material is confidential and proprietary and may not be used other than by the intended user. Neither Legg Mason or its affiliates or any of their officer or employee of Legg Mason accepts any liability whatsoever for any loss arising from any use of this material or its contents. This material may not be reproduced, distributed or published without prior written permission from Legg Mason. Distribution of this material may be restricted in certain jurisdictions. Any persons coming into possession of this material should seek advice for details of, and observe such restrictions (if any).

This material may have been prepared by an advisor or entity affiliated with an entity mentioned below through common control and ownership by Legg Mason, Inc.  Unless otherwise noted the “$” (dollar sign) represents U.S. Dollars.

This material is only for distribution in those countries and to those recipients listed.

All investors and eligible counterparties in Europe, the UK, Switzerland:

In Europe (excluding UK and Switzerland), this financial promotion is issued by Legg Mason Investments (Ireland) Limited, registered office 6th Floor, Building Three, Number One Ballsbridge, 126 Pembroke Road, Ballsbridge, Dublin 4, D04 EP27. Registered in Ireland, Company No. 271887. Authorised and regulated by the Central Bank of Ireland.

All Qualified Investors in Switzerland:
In Switzerland, this financial promotion is issued by Legg Mason Investments (Switzerland) GmbH, authorised by the Swiss Financial Market Supervisory Authority FINMA.  Investors in Switzerland: The representative in Switzerland is FIRST INDEPENDENT FUND SERVICES LTD., Klausstrasse 33, 8008 Zurich, Switzerland and the paying agent in Switzerland is NPB Neue Privat Bank AG, Limmatquai 1, 8024 Zurich, Switzerland. Copies of the Articles of Association, the Prospectus, the Key Investor Information documents and the annual and semi-annual reports of the Company may be obtained free of charge from the representative in Switzerland.

All investors in the UK:
In the UK this financial promotion is issued by Legg Mason Investments (Europe) Limited, registered office 201 Bishopsgate, London EC2M 3AB. Registered in England and Wales, Company No. 1732037. Authorized and regulated by the Financial Conduct Authority. Client Services +44 (0)207 070 7444

All Investors in Hong Kong and Singapore:

This material is provided by Legg Mason Asset Management Hong Kong Limited in Hong Kong and Legg Mason Asset Management Singapore Pte. Limited (Registration Number (UEN): 200007942R) in Singapore.

This material has not been reviewed by any regulatory authority in Hong Kong or Singapore.

All Investors in the People’s Republic of China ("PRC"):

This material is provided by Legg Mason Asset Management Hong Kong Limited to intended recipients in the PRC.  The content of this document is only for Press or the PRC investors investing in the QDII Product offered by PRC’s commercial bank in accordance with the regulation of China Banking Regulatory Commission.  Investors should read the offering document prior to any subscription.  Please seek advice from PRC’s commercial banks and/or other professional advisors, if necessary. Please note that Legg Mason and its affiliates are the Managers of the offshore funds invested by QDII Products only.  Legg Mason and its affiliates are not authorized by any regulatory authority to conduct business or investment activities in China.

This material has not been reviewed by any regulatory authority in the PRC.

Distributors and existing investors in Korea and Distributors in Taiwan:

This material is provided by Legg Mason Asset Management Hong Kong Limited to eligible recipients in Korea and by Legg Mason Investments (Taiwan) Limited (Registration Number: (98) Jin Guan Tou Gu Xin Zi Di 001; Address: Suite E, 55F, Taipei 101 Tower, 7, Xin Yi Road, Section 5, Taipei 110, Taiwan, R.O.C.; Tel: (886) 2-8722 1666) in Taiwan. Legg Mason Investments (Taiwan) Limited operates and manages its business independently.

This material has not been reviewed by any regulatory authority in Korea or Taiwan.

All Investors in the Americas:

This material is provided by Legg Mason Investor Services LLC, a U.S. registered Broker-Dealer, which includes Legg Mason Americas International. Legg Mason Investor Services, LLC, Member FINRA/SIPC, and all entities mentioned are subsidiaries of Legg Mason, Inc.

All Investors in Australia:

This material is issued by Legg Mason Asset Management Australia Limited (ABN 76 004 835 839, AFSL 204827) (“Legg Mason”). The contents are proprietary and confidential and intended solely for the use of Legg Mason and the clients or prospective clients to whom it has been delivered. It is not to be reproduced or distributed to any other person except to the client’s professional advisers.