Get Our Outlook for the New Year. Our top strategists' forecasts are available. Request your free copy.

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
 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.

Investment recommendations

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 DonisanuPeter Donisanu

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

Risk Factors

Stocks offer long-term growth potential, but may fluctuate more and provide less current income than other investments. An investment in the stock market should be made with an understanding of the risks associated with common stocks, including market fluctuations.

Investing in foreign securities presents certain risks not associated with domestic investments, such as currency fluctuation, political and economic instability, and different accounting standards. This may result in greater share price volatility.

An index is unmanaged and not available for direct investment.

MSCI EAFE® Index (Europe, Australasia, Far East) is an unmanaged group of securities widely regarded by investors to be representations of the stock markets of Europe, Australasia and the Far East.

The U.S. Dollar Index (USDX) measures the value of the U.S. dollar relative to majority of its most significant trading partners. This index is similar to other trade-weighted indexes, which also use the exchange rates from the same major currencies.

Disclaimers

Global Investment Strategy (GIS) is a division of Wells Fargo Investment Institute, Inc. (WFII) WFII is a registered investment adviser and wholly-owned subsidiary of Wells Fargo & Company and provides investment advice to Wells Fargo Bank, N.A., Wells Fargo Advisors and other Wells Fargo affiliates. Wells Fargo Bank, N.A. is a bank affiliate of Wells Fargo & Company.

The information in this report was prepared by Global Investment Strategy. Opinions represent GIS’ opinion as of the date of this report and are for general information purposes only and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally. GIS does not undertake to advise you of any change in its opinions or the information contained in this report. Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this report.

This report is not intended to be a client-specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon.

There is no assurance that any of the target prices or other forward-looking statements mentioned will be attained. Any market prices are only indications of market values and are subject to change.

Brokerage products and services are offered through Wells Fargo Advisors. Wells Fargo Advisors is the trade name used by two separate registered broker-dealers: Wells Fargo Advisors, LLC and Wells Fargo Advisors Financial Network, LLC, Members SIPC, non-bank affiliates of Wells Fargo & Company. First Clearing, LLC. Member SIPC, is a registered broker-dealer and Non-bank affiliate of Wells Fargo & Company.

 
CEX1607
CAR0115-03473