What is the outlook for international stocks in 2019? This is a common question on investor’s minds after 2018 turned out to be a dismal year for stocks around the world. In this post, I compare the valuation of stocks and prospects for growth in the U. S. versus those in international markets. I also analyze the potential for changes in currency exchange rates impacting international stock returns and answer the question: What is the outlook for international stocks in 2019?
Although global stock markets started 2018 with optimism, investors did not have much to cheer by year-end.
Every major type of investment or asset class fared poorly last year.
Developed international markets and emerging international markets did not extend their outperformance of U. S. stocks from 2017 to 2018.
Developed market stocks as measured by the MSCI EAFE Index lost 13.8% in U. S. dollar terms last year.
In comparison, emerging market stocks as measured by the MSCI Emerging Markets Index declined 14.6% in U. S. dollar terms.
Meanwhile, the MSCI USA Index designed to measure the performance of the large and mid-cap segments of the U. S. market lost 5.0%.
Outlook for International Stocks in 2019: Valuation Perspective
International stocks were more attractively valued compared to U. S. stocks at the start of 2018.
The underperformance of international stocks vis-a-vis U. S. stocks in 2018 has enhanced their appeal from a valuation perspective.
According to MSCI, stocks in the MSCI EAFE Index and MSCI Emerging Markets Index trade at a forward price-to-earnings ratio of 12.6 and 11.4, respectively.
In comparison, stocks in the MSCI USA Index trade at a forward P/E ratio of 16.0.
Outlook for International Stocks in 2019: Growth Perspective
The World Bank forecasts global economic growth to edge down to 2.9% in 2019 from 3.0% in 2018.
The bank expects growth in advanced economies to moderate slightly to 2.0% in 2019 from 2.2% in 2018 as central banks gradually remove their post-crisis accommodative monetary policies, global trade slows, and capacity constraints become increasingly limiting.
The bank expects the emerging markets and developing economies to grow by 4.2% in 2019, matching their rate in 2018. This forecast is 0.5% lower than the previous one. The World Bank expects the emerging market and developing economies to be challenged by weaker global trade and higher borrowing costs.
Looking at specific countries and regions, the U. S. economy is expected to grow by 2.5% in 2019, down from 2.9% in 2018. Benefits from lower tax rates implemented in 2018 are expected to fade in 2019 while uncertainty over trade tariffs is expected to weigh on investment.
Growth in the Eurozone is forecasted to decelerate to 1.6% in 2019 from 1.9% last year as monetary stimulus is withdrawn. The European Central Bank ended its quantitative easing stimulus program in 2018 and may begin raising interest rates by mid- to late-2019.
China’s economy is forecasted to grow 6.2% this year, down from 6.5% in 2018. Chinese exports are expected to weaken from higher tariffs while domestic demand is projected to stay strong from policies to boost consumption.
On the brighter side, South Asia is expected to remain the world’s fastest-growing region. Led by India, growth in South Asia is projected to accelerate to 7.1% in 2019 from 6.9% in 2018. A pickup in domestic demand from credit growth and structural reforms such as the implementation of Goods & Services Tax is expected to accelerate the growth of the Indian economy to 7.5% in 2019 from 7.3% in 2018.
Outlook for International Stocks in 2019: Currency Conversion Perspective
The trade-weighted dollar index rose 4.6% in 2018.
Helping the advance, the Federal Reserve raised its benchmark short-term interest rates four times last year.
In contrast, the European Central Bank (ECB) and the Bank of Japan (BOJ) continued to remain highly accommodative. The ECB and the BOJ kept their benchmark short-term interest rates unchanged through 2018 at 0% and -0.1%, respectively.
The Fed is ahead of the ECB and BOJ in normalizing interest rates after the Great Recession. The Fed has already upped interest rates 9 times since late 2015, raising its benchmark short-term interest rate from 0.25% to 2.5%. The ECB and the BOJ are yet to start normalizing interest rates.
If the ECB stays true to its indication of raising short-term interest rates in the latter part of 2019, the interest rate differential between the U. S. dollar and the Euro should start to narrow and drive the U. S. dollar lower.
As such, the odds of the U. S. dollar continuing its ascent against major currencies appear low and a modest weakening could be in the offing in 2019.
Outlook for International Stocks in 2019: Bottom Line
Developed as well as emerging market stocks have lagged U. S. stocks over the past 5- and 10-year timespans.
Over the past 5 years, MSCI USA Index is up a cumulative 45% compared to 3% and 9% for the MSCI EAFE Developed Market Index and the MSCI Emerging Markets Index, respectively.
Likewise, the MSCI USA Index is up 223% over the past 10-years while the MSCI EAFE Index and the MSCI Emerging Markets Index are up 85% and 116%, respectively.
Similar divergences have occurred in the past and have usually been resolved by strong performances from the lagging benchmarks.
International stocks currently have the right attributes to lead U. S. stocks: superior valuation, stronger growth prospects, and currency conversion effects that can work in their favor.
The tide may well change if the U. S.-China trade spat is resolved without undue delay and economic growth in Europe surprises to the upside.
As such, the answer to the question what is the outlook for international stocks in 2019? is Favorable. Now, is not the time to give up on international investing. If anything, now is the time to increase allocation to international stocks.