Making the Case for Increasing International Equity Exposure

Navigating Market Uncertainty: Why International Equities Deserve a Closer Look

Investors are no strangers to market uncertainty, and global events continue to influence equity markets and currency movements in ways that can be difficult to predict. As we evaluate the landscape, several factors might support increasing exposure to international equities—particularly with a thoughtful approach to currency risk.

Tariffs and Currency Movements: A Look Back

One key dynamic that can impact international investing is the relationship between tariffs and currency movement. From the U.S. perspective, tariffs, without retaliation from foreign countries, tend to support the dollar for a few reasons. First, by reducing imports, they limit the flow of dollars abroad, tightening global dollar supply. That can narrow the trade deficit, which historically supports a stronger dollar. Second, tariffs can trigger capital inflows if investors anticipate domestic industries benefiting from protectionist measures.  On the other side, for foreign economies, a stronger dollar mechanically translates into weaker local currencies.

Recent history supports this point. For example, in 2018, when trade tensions escalated due to tariffs on Mexico, Canada, China, and other nations, the U.S. Dollar appreciated by roughly 10%—following a prior period of about 12% weakness. More recently, in the 2022 global market drawdown, the Dollar Index (DXY) surged over 26% from trough to peak, a move typical of a "flight-to-quality" environment. These shifts highlight the potential unpredictability of currency markets and reinforce the importance of managing international equity exposure thoughtfully.

Positioning for the Unknown: A Balanced Approach to Currency Hedging

While currency movements remain uncertain, investor sentiment around international equities can be shaped by concerns about currency risk. Regardless of whether these risks materialize, conversations around foreign equity investing tend to be driven by factors such as portfolio diversification to U.S. equities, perceived performance potential, and fear of uncertainty.

One way to navigate uncertainty and help manage volatility as measured by standard deviation is through a balanced hedging approach. A 50% currency hedge, for example, might serve as a strategic middle ground:

• If foreign currencies continue to weaken, the hedge can help mitigate the headwind.
  
• If foreign currencies strengthen, investors still participate in the equity returns along with half of the currency move.

This approach can offer the equity benefits of international diversification while reducing volatility compared to fully unhedged strategies, such as the widely-used passive international index ETFs.

Favorable Growth Conditions: A Supportive Backdrop for International Equities?

A key consideration for international equities is the prevailing macroeconomic environment. Historically, international markets have performed well under conditions of moderate growth and controlled inflation. U.S. growth has exhibited a period of exceptional expansion, which could provide a relative advantage for international equities in the years ahead.

• A peace dividend, or at least the prospect of one, could lift international equities, as uncertainty falls and economic activity increases, especially in sectors impacted by the Russian invasion of Ukraine.
• Inflation expectations abroad have moderated and may be headed towards stability. Persistent inflation in the U.S. is limiting the Federal Reserve's ability to provide monetary support, while other central banks, facing less entrenched inflation, may continue accommodative policies.
• Valuations in international markets remain attractive, particularly in Europe, Japan, and select emerging markets like Mexico and China.

If these conditions persist, international equities could benefit from renewed investor interest and capital flows.

International Equities: A Timely Diversification Opportunity?

The case for diversifying beyond U.S. equities is well known, but today, it might be more relevant than ever. Consider the historical context:

• Over the past six out of eight years, the S&P 500 has delivered an average annual return of 25.3%.
• Similar streaks of strong U.S. equity returns occurred in the mid-to-late 1990s and late 1970s/early 1980s. In both cases, international equities, as represented by the MSCI EAFE Index, experienced strong subsequent periods of relative performance.
• From 2000 to 2007, the MSCI EAFE Index outperformed the S&P 500 by 36% (unannualized), while the local equity version (does not include currency impact) exhibited lower drawdowns.

About Risk:

Past performance is no guarantee of future results, which will vary. All investments are subject to market risk and will fluctuate in value. Diversification cannot assure a profit or protect against loss in a declining market.

Foreign securities can be subject to greater risks than U.S. investments, including currency fluctuations, less liquid trading markets, greater price volatility, political and economic instability, less publicly available information, and changes in tax or currency laws or monetary policy. These risks are likely to be greater for emerging markets than in developed markets.

Definitions:

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 is an equity index which captures large- and mid-cap representation across 21 developed markets countries around the world, excluding the U.S. and Canada. The index covers approximately 85% of the free float-adjusted market capitalization in each country.

The U.S. Dollar Index (USDX, DXY, DX, or informally the “Dixie”) is an index of the value of the United States dollar relative to a basket of foreign currencies, often referred to as a basket of U.S. trade partners’ currencies.  The index is designed, maintained, and published by ICE (Intercontinental Exchange, Inc.), with the name “U.S. Dollar Index” a registered trademark.

Standard deviation is a statistical measurement in finance that, when applied to the annual rate of return of an investment, sheds light on that investment’s historical volatility.

A Peace Dividend refers to the idea that money spent less on arms and more toward ending conflict and fulfilling human needs could spur greater long-term economic growth.

Free cash flow yield (FCFY) measures a company's profitability relative to its market value, focusing on the cash flow generated rather than accounting profits, and is calculated by dividing free cash flow per share by the current share price.

Forward price-to-earnings (P/E) ratio uses a company's projected earnings for the next 12 months to calculate how much investors are paying for each dollar of future earnings, calculated by dividing the current stock price by the estimated earnings per share (EPS) for the upcoming year.

Disclosures:

Opinions expressed herein are current opinions as of the date appearing in this material only. Investing involves risk, including possible loss of principal. Asset allocation and diversification may not protect against market risk, loss of principal or volatility of returns. There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors, and each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market. No representation is being made that any account, product, or strategy will or is likely to achieve profits.

This material represents an assessment of the market environment as of a specific date; is subject to change; and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the funds or any issuer or security in particular.

This material contains general information only and does not take into account an individual’s financial circumstances. This information should not be relied upon as a primary basis for an investment decision. Rather, an assessment should be made as to whether the information is appropriate in individual circumstances and consideration should be given to talking to a financial advisor before making an investment decision.

“New York Life Investments” is both a service mark, and the common trade name, of certain investment advisors affiliated with New York Life Insurance Company.  Securities distributed by NYLIFE Distributors LLC, 30 Hudson Street, Jersey City, NJ 07302, Member FINRA/SIPC.