After a stellar 2017, with strong returns and outperformance relative to the U.S., international equities are under pressure again. In order to consider how long this dynamic may last, investors may be asking themselves: why exactly are international stocks down this year?

We can break down equity returns into their four main building blocks: dividends, earnings, multiples and the currency effect. Looking at this year’s breakdown for the major regions around the world, we can see that dividends and earnings have contributed to returns, while multiples and currencies have detracted from them. This exemplifies the tug of war in international markets between positive fundamentals and negative sentiment.

On the positive fundamentals side of the battle field, the global economy continues to be in much better shape than the crisis-filled years of 2011 to 2016. Economic data abroad, especially in the Eurozone and Japan, did disappoint in the first half of the year; however, this is relative to very high expectations. In reality, economic growth abroad has cooled a bit, but from the very hot summer months of 2017. In addition, data have begun to improve once again in the Eurozone, Japan and EM. As a result, international earnings growth has continued the positive trajectory begun in 2016. This year, expectations are still for 16% earnings growth in EM, 7% in the Eurozone and 4% in Japan ((in U.S. dollar terms). Next year, earnings across the main regions are expected to grow by 10%, on pace with those in the U.S.

On the negative sentiment side, investors have begun to consider the risks to this currently positive fundamental picture. These include potential direct and indirect negative effects from ongoing trade tensions, as well as second order negative effects of dollar strength for emerging economies. The risks to the positive outlook have increased; however, the silver lining is that international valuations and currencies have already declined to reflect this, especially in EM.

Over the past few months, sentiment has been winning the battle internationally. However, given how much negativity already prevails, improvements in economic data, trade tensions and dollar movements would give investors more conviction in the outlook once again. Fundamentals may not win every battle, but they do tend to win the war.

When sentiment takes over

Sources of global equity returns, total return, USD

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Source: FactSet, MSCI, Standard & Poor’s, J.P. Morgan Asset Management.
All return values are MSCI Gross Index (official) data, except the U.S., which is the S&P 500. Multiple expansion is based on the forward P/E ratio and EPS growth outlook is based on NTMA earnings estimates. Data are as of September 21, 2018.