While 2023 may see the storm hit the real economy, 2022 was the year the storm was felt in financial markets, including international equities (with the MSCI All Country World Index ex-U.S. down 15% in U.S. dollars). Will the sun shine brighter in 2023?

This year’s negative returns were driven by a sizable multiple contraction of 15% and a drag from currency weakness of 9%. Earnings themselves held up because of still resilient demand, higher prices, weaker currencies benefiting exporters and elevated commodity prices benefiting energy and materials companies. 2023 will likely see the reverse, with still elevated earnings expectations needing to be revised lower (especially in Europe where consensus still looks for 0% earnings growth amidst a very likely recession), likely offset by some multiple expansion and currency strength as investors gain more confidence the worst has been priced into expectations as the year goes on.

While multiple contraction also occurred in the United States in 2022, the starting point there was much higher, leaving U.S. equities at average valuations. In contrast, every other major region now has valuations significantly below their long-term averages, especially Japan (-35%), Europe (-18%), and China (-15%). As a result, the valuation discount of international equities to U.S. markets is now at -30%, even larger than at the start of the year. While risks around the international growth outlook are high for 2023, they are also much better reflected in valuations – and “less bad” news can be enough to fuel a powerful rebound once the worst is priced into earnings expectations.

In particular, Chinese equities (and hence broader emerging markets) have the potential to be the first to turn in the right direction. China’s valuations are now at low levels comparable to previous reform and regulatory cycles (2008, 2011, 2015, 2018), its next 12 months’ earnings expectations are lower versus the start of the year by 11 percentage points, positioning is light following two years of a bear market and positive catalysts for investor confidence are taking shape. These include a move toward more pragmatic implementation of “zero COVID” policy and housing reforms, as well as a dialing down of tensions with the United States and other Western countries. With that said, it is key for investors to invest in the “new new China” by focusing especially on A-shares, which grant exposure to the priority areas of business technology, domestic demand and the energy transition.

While investors’ portfolios’ exposure to international has decreased significantly during the asset class’ decade plus of underperformance versus U.S. equities (with the average advisor portfolio analyzed by our Portfolio Insights team holding a 10 percentage point underweight to international equities), the strategic investment opportunities overseas have not shrunk. Quite the opposite, they have gained in size and relevance for generating strong returns in the future. These themes include the technology needed to transform the global economy, the solutions needed to engineer an energy transition, the traditional energy to keep the global economy humming in the meantime and the growth of the new class of consumers. These are themes that can be found across regions, such as business technology companies in China, Korea and Taiwan; renewable energy, commodity and electric vehicle companies in Europe, China and Latin America; energy companies in Latin America, the Middle East and Canada; and luxury goods companies listed in Europe that derive the majority of their revenue from emerging consumers. Historically, investors have been rewarded for investing when confidence is already depressed due to cyclical considerations. The average 12-month subsequent return after previous Eurozone consumer sentiment troughs (such as these) of 29% in local currency, suggest strong sunshine up ahead, perhaps in 2023.

Already depressed sentiment suggests strong returns up ahead

European Commission Consumer Confidence Index and subsequent 12-month MSCI EMU return (LCL)

Source: European Commission, FactSet, MSCI, J.P. Morgan Asset Management. Peak is defined as the highest index value before a series of lower lows, while a trough is defined as the lowest index value before a series of higher highs. Subsequent 12-month MSCI EMU returns are price returns only in local currency, which excludes dividends. Past performance is not a reliable indicator of current and future results. Data are as of December 5, 2022.