Global Macro Strategy
March 24, 2015
Peter Donisanu, Global Research Analyst
Analysis and outlook for the global economy
- Some investors question whether the latest developed-market equity rally is sustainable; and if so, can U.S. investors truly benefit from a strong U.S. dollar.
- We believe that a virtuous circle of events is underway which may support developed-equity markets in the coming months. History has shown that a strong U.S. dollar does not necessarily preclude U.S. investors from benefiting from positive performance in other developed markets.
What it may mean for investors
- Investors should consider now a good time to reallocate from fixed income into equities, both in U.S. and developed-market holdings.
Developed-Market Equities: Can a Sustainable Rally Benefit U.S. Investors?
Developed-market stocks returned modest gains to U.S. investors this year in spite of a sharp appreciation in the U.S. dollar. Some investors are questioning whether the rally in developed-market equities is sustainable; and if so, can they benefit from a strong U.S. dollar. We believe that a foundation is being set for a continued rally in developed-market stocks that is supported, in part, by historical precedent. We also anticipate that the U.S. dollar will maintain its strength vs. international currencies; nevertheless, we hold the view that U.S. investors may experience net-positive, currency-adjusted returns which supports our current tactical recommendation to reallocate from fixed income into equities, in both U.S. and developed-market holdings.
From the start of the year through last Friday's close, developed-market equities have gained 4.4 percent in U.S. dollar terms.1 The rally in these markets follows a virtuous circle of events. Central bank easing has led to improvements in consumer and business confidence, supporting a broad expansion in economic activity and modest growth in corporate earnings. While the factors present today could be enough to encourage investors to acknowledge the sustainability of a rally in developed markets, this cycle is further supported by a comparable series of events that occurred in the 1990s.
One period of time somewhat similar to today is that between 1998 and 1999. Like today, back in 1998 the U.S. dollar was strong, oil prices were in decline, advanced economies were sluggish, and equity markets sold off sharply-but the following year marked a turning point for developed markets. An improvement in consumer confidence among major developed economies was followed by gains in household spending and business investment. Amidst the improving macroeconomic backdrop, developed-market equities rallied and closed the year up 25.3 percent in U.S. dollar terms despite the currency's strength.
Today's economic and financial environment bears some resemblance to the period between 1998 and 1999. But, an important contributor to previous economic recoveries that appears to be missing this time around is business investment. While investment may have improved last year, the overall recovery remains historically weak. Nevertheless, we believe that improving confidence and easing lending conditions could pave the way for a broad recovery in investment activity as soon as the second half of this year.
Table 1: U.S. Investors Can Benefit in a Strong U.S. Dollar Environment
Source: WFII; Bloomberg, 3/23/15; Note: Developed Market Index reflects MSCI EAFE total return index in local and USD returns. The U.S. Dollar vs. Major Currencies reflects changes in the headline U.S. Dollar Index.
Improving economic factors may support a developed-market equity rally, but can overseas' returns outpace a strong U.S. dollar? Between 1998 and 2014 we have observed five years in which the U.S. dollar and developed-market equities appreciated concurrently. In those five years, we noted only one year (2014) when currency-adjusted returns were negative. Even in periods of an extended U.S. dollar rally, developed-market equities managed to return over 15 percent in dollar-adjusted terms.
Overall we believe that a similar cycle of events is underway which may support developed-equity markets in the coming months. We anticipate that the U.S. dollar will maintain its strength vs. developed-market currencies as a result of central bank easing in many developed markets coupled with expectations for tightening from the Federal Reserve later in the year. Nevertheless, a strong U.S. dollar does not necessarily preclude U.S. investors from benefiting from positive performance when currency-adjustments are factored into international returns. As improving financial conditions in developed economies help provide a favorable environment for stocks, investors should consider now a good time to reallocate from fixed income into equities, in both U.S. and developed-market holdings.
1 Morgan Stanley Capital International Europe, Australasia and the Far East Index
Peter Donisanu is a global research analyst for Wells Fargo Investment Institute (WFII), an organization that provides global manager research and investment strategy advice to Wells Fargo's Wealth, Brokerage, and Retirement (WBR) division. WBR is comprised of Wells Fargo Private Bank, Wells Fargo Advisors, Wells Fargo Institutional Retirement, and Abbot Downing businesses, accounting for more than $1.6 trillion* in assets under administration.
In his current role, Mr. Donisanu is responsible for building a broad, multi-asset-class strategy view for international developed and emerging markets and communicating these strategic views through client-facing and internal publications. He has been with Wells Fargo for 13 years and has served in a variety of consulting, financial management, and analytical roles.
Mr. Donisanu earned a Bachelor of Science in Business from ITT Technical Institute and a Masters of Business Administration with an emphasis in Finance from City University of Seattle. He is located in San Francisco.
*As of Sept. 30, 2014
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