The Spotlight Blog

Trade Talks: A Broken Record

 

Intensification of the China-U.S. trade tensions in August gave investors little reason to rotate away from what has been working on a relative basis, making investors who are overweight international equities relative to the U.S. likely feel like that part of their portfolio is a broken record, which keeps playing the same song of U.S. outperformance.

Even with international markets trading at their highest ever discount to the U.S. on multiple valuation measures, our framework suggests that the U.S. remains favorable to international markets until we see a change in relative momentum that shows some support for international firms.

US Stock Outperformance with More Volatility

  • Interestingly, as the U.S. has consistently outperformed, it has done so with greater volatility. In fact, the average realized volatility of the Russell 1000 Index has been 50% higher than that of the FTSE All-World ex US Index this year.
  • In August, U.S. volatility was 75% higher than in July after both the U.S. and international markets were subdued thanks to the hopes of more accommodative monetary policy and a then de-escalation of the trade war that failed to materialize putting investors again on edge.

Volatility has been Higher in the U.S. Markets than International Ones

Source: FTSE Russell, as of September 3, 2019. U.S. represented by the Russell 1000® Index and international represented by the FTSE All-World ex US Index. One cannot invest directly in an index.

Money in Motion

The magnitude of net flows across both U.S. and international-focused ETFs has decreased this year compared to 2018 with combined year-to-date 2019 flows only one fifth of what we saw in 2018. However, ETF investors are showing a clear preference for the U.S. so far this year.

  • With $4.9 billion of inflows, U.S. ETFs have seen $2.3 billion greater net flows than international ETFs through the first two months of Q3 2019. However, investors did reverse course in August as international ETFs were modestly positive with $753 million of inflows, but the U.S. saw $4.8 billion of outflows.
  • In Q2, international ETFs took in $2.3 billion more flows primarily thanks to May’s $16.1 billion of outflows from the U.S. One should note that returns for both markets were sharply weaker in May compared to last month’s returns.

U.S. Relative to International ETF Flows have been Muted

Source: Bloomberg Finance, L.P., as of January 1, 2018 to September 3, 2019. Data represents the net flows of U.S.-listed U.S. Equity ETFs and International Equity ETFs, specifically targeting exposure to U.S. and international markets, respectively. For example, when the blue or orange bars are positive, net flows were positive. On the other hand, when the blue or orange bars are negative, net flows were negative.

Still the Nicest House on the Block

Tuesday’s release of August’s U.S. Manufacturing PMI saw the U.S. joining many of its international peers in seeing a contraction in economic data as the impact of tariffs sees its way across global supply chains making the backdrop for equities more connected to manufacturing, such as those outside of the U.S., riskier than those more connected to services-orientated sectors.

  • With this relative performance record on repeat, there lacks a clear catalyst for a shift to international shares from the U.S. One such impetus toward rotation would be an increase in inflationary forces likely coming from an improvement in global growth. Over the last 20 years, the correlation between the ratio of international relative to U.S. performance and commodities is 0.83, highlighting a strong linkage between the two.
  • Without an increase in pricing pressures, U.S. companies’ better earnings growth potential and healthier balance sheets see them better positioned to navigate what will likely be an increasingly difficult macroeconomic environment as we look to year-end.

International Shares have Slumped Along with Commodities

Source: Bloomberg Finance, L.P., FTSE Russell, as of August 31, 2019. U.S. represented by the Russell 1000 Index, international represented by the FTSE All-World ex US Index, and commodities represented by the Bloomberg Commodity Index. One cannot invest directly in an index.

Implementation Ideas: Depends on Your Conviction.

 


Definitions

  • Russell 1000® Index: The Russell 1000® Index consists of the largest 1,000 companies in the Russell 3000 Index, which is made up of 3,000 of the largest U.S. companies.
  • FTSE All-World ex US Index: The FTSE All-World Excluding United States Index is a free float market capitalization weighted index. FTSE All-World Indices include constituents of the Large and Mid-capitalization universe for Developed and Emerging Market segments.

 

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