Does the resurgence of the greenback mean an end to International Equities dominance?

Here’s what investors need to know… The direction of the U.S dollar has a big impact on how U.S. stocks perform relative to foreign stocks.

As a rule, a strong dollar favors U.S. stocks, while a weak dollar favors foreign stocks.

You might have noticed that the recent rise of the greenback against foreign currencies is causing foreign stocks to underperform the U.S.

In the process, it’s giving a strong dose of heartburn to investors who – hoping to cash in on the Asset Classes lofty returns of 2017, jumped in with both feet.

You might remember that International Equities were the second strongest Asset Class (behind only U.S. Equities) in 2017 and offered some of the highest returns of the year.

The chart below shows how the relationship between the dollar and foreign securities has worked over the last 20 years.

The blue line is a “relative strength ratio” comparing the relative strength of MSCI World (ex USA) Stock index to the S&P 500 since 1998, while the green bars plot the U.S. Dollar Index.

Even to the untrained eye, it seems pretty clear that the two lines generally trend in opposite directions.

We can see from this 20 year chart that, as the dollar fell sharply between 2002 and 2008 (green line), foreign markets rose (blue line).

But since the dollar began to strengthen after bottoming in 2008, foreign stocks had generally underperformed (falling blue ratio) – until 2017, when the dollar once again weakened – at least temporarily.

During 2017, the dollar reversed lower (red circle), resulting in strong performance of many International securities.

Both the iShares MSCI EAFA ETF (EFA) and the iShares MSCI Emerging Markets ETF (EEM) – often referenced as benchmarks for International Developed and Emerging Markets, outpaced the S&P 500 Index, with the Emerging markets fund nearly doubling the returns of the S&P.

Between December 30, 2016 and January 3, 2018, the S&P 500 Index gained 18%, while EFA gained 26.60%  and EEM 41.20%.

Impressive returns, but many investors are asking, “what’s next?”

For followers of relative strength analysis, this is when we are reminded to follow our rules and remember to seek out strength, wherever it may be.

Investors should recall that International Equities still remain the second strongest Asset Class, on a long-term basis, according to our global asset map.

This means that demand remains in control of the Asset Class when taking a long-term view.  The long-term relative strength trend of International Stocks’ outperformance remains intact.

Certainly, there is general weakness in the direction of International Equities right now – as seen in our market proxies, EFA and EEM. But as the expression goes, don’t throw the baby out with the bath water (and no, I have no idea where that expression originated).

The Relative Strength still present in International Equities implies there is still opportunity in the sector. Applying relative strength analysis can help find the bull markets driving this strength.

For example, three of the top four funds in our Developed markets matrix are outperforming all three market proxies.

The bar chart below includes ETF’s from both Developed and International Markets.

If you’re a client of Rowe Wealth, this is just some of the data we’ll be using to rebalance portfolios that have exposure to developed and international markets. As always, we’ll be using relative strength data to determine which sectors are still gaining strength, and which are being adversely affected by the rising value of USD.

If you’re not already one of our clients, and you have money invested in international ETFs, you should be sure to check with your advisor(s) to make sure they’re aware of these developments.

If this is news to them, you might want to consider scheduling a consultation with one of our advisors. This consultation doesn’t carry any commitment, you’re more than welcome to simply call and ask for more details about how you can avoid some of the risk associated with international markets at this time.

Click here to see our available appointment times.