The Outlook for International Stocks

Global stocks have come under pressure in the first half of 2022. The war in Ukraine has created volatility and uncertainty in the energy markets, and inflation is rising around the world – not just in the US. To make matters even more challenging, China instituted strict lockdowns in major economic centers like Shanghai, which dented activity and disrupted supply chains further. The only significant areas of respite from the downside volatility were in commodity-driven markets like Canada and Australia, which held up reasonably well.¹

Looking ahead, an unfortunate reality is that the war in Ukraine is showing few signs of ending anytime soon. Russia has also been applying leverage over Europe in the gas markets, by cutting the flow of natural gas down to 20% of normal capacity. Taken together, these factors have driven European economic uncertainty (blue line) and global economic policy uncertainty (red line) to levels not seen since June 2016 – when the United Kingdom voted to leave the European Union (Brexit).

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Economic data in Europe has remained relatively resilient in the face of all of these headwinds and uncertainty, as consumers there also had pent-up savings much like their American counterparts. But the outlook is less certain, particularly as no one knows how far Russia will go in curbing natural gas flows. Russia currently blames European and US sanctions on its inability to operate the Nord Stream pipeline any higher than 20% capacity, but the more likely cause is Russia retaliating against those very sanctions.

Europe has reached a watered-down deal to reduce natural gas consumption in the coming months, and is actively seeking new trading partners. But the likelihood of needing to shut down factories and limit natural gas usage in the winter months is growing, which also means recession risk is growing. The European Central Bank’s tilt to hawkishness in the face of rising inflation isn’t helping.

In Zacks Advantage portfolios, we have trimmed international small-cap exposure and effectively shifted the portfolio into a more defensive posture. We remain significantly underweight in our developed country’s international exposure.

As far as the Emerging Markets segment of the international equity outlook is concerned, we have a much more optimistic view of China. The severe lockdowns in response to Covid-19 outbreaks in Shanghai and other provinces led to a sharp slowdown in manufacturing, services, and consumption activity. But as we’ve seen from previous lockdowns elsewhere in the world, economic activity rebounds quickly once restrictions are lifted. That’s what we’ve seen in China so far.

China’s President, Xi Jinping, has also called for “growth-boosting policies” and recently announced $120 billion in funding for infrastructure spending. China’s central bank, the People’s Bank of China, confirmed its commitment to provide accommodative fiscal and monetary policies as the country continues to push ahead with its zero-Covid strategy. Lastly, if the Chinese government reduces the ambiguity around its regulations on technology companies, which appears possible, investors could regain the confidence to invest in the region. In our view, the potential upside in the Chinese economy is unique within a global economy otherwise struggling to generate growth.

One possible silver lining in the global economic outlook, however, comes from supply chains. Snarled supply chains have been a great source of frustration for consumers in the form of delayed goods and rising prices. But signs are pointing to some of the supply chain stresses being relieved. The New York Fed’s Global Supply Chain Pressure Index has been falling over the past few weeks, which gathers data from shipping and airfreight indicators as well as PMI surveys from key countries like the US, China, Japan, and South Korea. As seen on the chart below, pressure is easing and supply delivery times are falling from highs – both good signs.

Global Supply Chain Pressure Index

Bottom Line for Investors

Much of the focus in Europe and Emerging Markets has been on decelerating economic growth, but the direction of earnings is likely to be the key determinant for stock prices looking ahead. The current P/E ratio for the MSCI EAFE index is at long-term lows not seen since the recessions of the past few decades, which in our view opens up the possibility for earnings resilience leading to an upside surprise. Low valuations may not save stock prices if earnings deteriorate from here, however, which for Europe will hinge on the natural gas situation and for China will hinge on the Covid-19 situation.

Another upshot for the investment outlook is that historically, high and rising inflation expectations have led foreign stocks to outperform domestic US stocks. According to an analysis from Charles Schwab, international markets have more companies that benefit from higher inflation than those that suffer, which could drive more earnings resilience abroad than we see domestically. We think the uncertainty of the moment calls for staying underweight developed international markets with a bias toward Emerging markets.

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¹ Charles Schwab. June 6, 2022.

² Zacks Investment Management may amend or rescind the Revolutionize Your Retirement guide offer for any reason and at Zacks Investment Management’s discretion.

³ Fred Economic Data. July 1, 2022.

⁴ Federal Reserve Bank of New York. June 2022.

⁵ Zacks Investment Management may amend or rescind the Revolutionize Your Retirement guide offer for any reason and at Zacks Investment Management’s discretion.

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