While the 2023 outlook is still uncertain, “less bad” news helps to reduce uncertainty when a lot of negativity has already been priced into multiples and currencies.
Gabriela Santos
Global Market Strategist
Hello. My name is Gabriela Santos, and I'm a global market strategist at J.P. Morgan Asset Management. Welcome to On the Minds of Investors. Today's topic is, have international equity markets already priced in the worst? International equities are down 13.6% year to date in US dollars with multiple contraction and weaker currencies dragging on returns, and as investors price in higher rates and more uncertainty about fundamentals.
The path ahead is still uncertain, especially for Europe, given the ongoing electricity price shock, as well as China, given its bumpy transition away from zero COVID, but valuations and currencies now better reflect investors' gloominess. As seen in November when depressed valuations and low positioning meet less bad news, a powerful rally can occur. But for investors to capture the rebound, they need to be invested to begin with.
A substantial underweight to the asset class suggests ample room to position portfolios for what's ahead versus what's already behind us. This year, international equity multiples have contracted 14 percentage points, leaving the forward price to earnings ratio sitting 10% below 25-year averages. And this compares to US valuations, which are now 3% above the long run average.
In addition, currencies have weakened 7% versus the dollar, leaving many near multi-decade lows. Said another way, the dollar is nearly the most expensive it's ever been in 40 years. So these starting points suggest that international markets offer more of an uncertainty premium than US markets do, and already offer a substantial discount for the uncertainties ahead, such as a recession in Europe and a bumpy path out of zero COVID for China.
And as previously argued, when sentiment is already so gloomy, markets are left vulnerable to more favorable news. And recently, the situation overseas has started to look less dire than investors originally thought with natural gas storage levels in Europe nearly full going into what's so far been a mild winter. In China, the conclusion of the National Party Congress led to more pragmatic measures around COVID, real estate, and China's relationship with the rest of the world.
So the 2023 outlook is still uncertain, but less bad news helps to reduce uncertainty, especially when a lot of negativity has already been priced into multiples and currencies. And indeed in November, international equities were up 11.8%, that's 7.8 in local currency, plus 3.9% currency appreciation versus the dollar. And this represented an outperformance of 620 basis points versus US equities that month. And now leaves international equities outperforming the US year to date.
So it's key for investors to realize that there will never be a perfect time to invest in international equities. But instead, what we can see is that today provides a historically attractive entry point for investors to at least lessen their very deep underweight to international equities in order to just not be caught offsides for what may lie ahead.
International equities are down -13.6% year-to-date (in U.S. dollars), with multiple contraction and weaker currencies dragging on returns, as investors price in higher rates and more uncertainty about fundamentals. The path ahead is still uncertain, especially for Europe given the ongoing electricity price shock, as well as China given its bumpy transition away from “Zero COVID”; however, valuations and currencies now better reflect investors’ gloominess. As seen in November, when depressed valuations and low positioning meet “less bad” news, a powerful rally can occur. However, for investors to capture the rebound, they need to be invested to begin with. A substantial underweight to the asset class suggests ample room to position portfolios for what’s ahead versus what’s behind us.
This year, international equity multiples have contracted 14 percentage points, leaving its forward price-to-earnings ratio sitting 10% below the 25-year average. This compares to U.S. valuations now 3% above its long-run average. In addition, currencies have weakened 7% versus the U.S. dollar, leaving many near multi-decade lows. Said another way, the U.S. dollar is nearly the most expensive in 40 years. These starting points suggest that international markets offer more of an uncertainty premium than U.S. markets do – and already offer a substantial discount for the uncertainties ahead, such as a recession in Europe and a bumpy path out of “Zero COVID” for China.
As previously argued, when sentiment is so gloomy, markets are left vulnerable to more favorable news. Recently, the situation overseas has started to look less dire than investors originally thought, with natural gas storage levels in Europe nearly full going into (a so far mild) winter. The conclusion of China’s National Party Congress led to more pragmatic measures around COVID, real estate, and China’s relationship with the rest of the world. While the 2023 outlook is still uncertain, “less bad” news helps to reduce uncertainty when a lot of negativity has already been priced into multiples and currencies.
In November, international equities were up 11.8% (+7.8% in local currency plus 3.9% currency appreciation). This represented an outperformance of 620bps versus U.S. equities– now leaving international equities outperforming the U.S. year-to-date. It is key for investors to realize that there will never be a perfect time to invest in international equities. Instead, today provides a historically attractive entry point for investors to lessen their deep underweights1 to international equities in order to not be caught offsides for what’s ahead.
Multiple contraction and currency weakness has dragged on international returns
Year-to-date, total return, U.S. dollars
Source: FactSet, MSCI, Standard & Poor’s, J.P. Morgan Asset Management.
All return values are MSCI Gross Index (official) data. Multiple expansion is based on the forward P/E ratio, and EPS growth outlook is based on NTMA earnings estimates.
Chart is for illustrative purposes only. Past performance is not indicative of future results.
Data are as of December 7, 2022.
1The average advisor portfolio analyzed by our Portfolio Insights team holds a 10-percentage point underweight to international equities versus a neutral allocation (25% vs. 35% allocation to international equities as a percentage of a total equity allocation).
09id220712140009