Inflection Point for Foreign Equities

Investing Environment Review and Outlook – Volume 49

After the unprecedented COVID market crash in 2020, by mid-year conditions (including a strong economic outlook, low inflation, a loose Fed, and skeptical investors) were ideal for U.S. stocks. However, the subsequent economic rebound and 40% S&P 500 rally since last June has cut the future expected return. The most obvious changes are investor positioning (short to long) and inflation (low to high). While most investors debate the case for cyclical vs. technology stocks, the bigger opportunity may be in mostly overlooked foreign equities. This month we discuss the inflection point for foreign equities, the elevated inflation data, and the extreme investor positioning. Asset ratings are unchanged this month. U.S. equities remain a bullish 4. Foreigndeveloped and emerging markets remain a bullish 5, along with gold and commodities. Longterm bonds remain a cautious 1 rating.

Inflection Point for Foreign Equities

For 13 years, the S&P 500 has dominated world equity returns. However, we believe foreign equity markets are likely entering a period of outperformance. Consider that since January 2008, the S&P 500 Index is up 186% vs. just 3.6% for the EAFE Index (which measures developed equity markets in Europe, Asia and the Far East). Even emerging markets stocks are just coming out of a 12-year period of underperformance. There are certainly good reasons for the divergence, including superior fundamentals in the U.S. like sales and earnings growth. However, the strong dollar, up 42% over that period, also played an important role. Dollar moves are inversely correlated to foreign equity’s relative performance. Today we have an inflection point catalyst in a weak dollar. From the 2020 peak, the Dollar Index is down over 10%, a move logical and consistent with prior quantitative easing periods when the supply of dollars was also increased. In addition, the Eurozone economy is surging, challenging the consensus narrative that Europe is perennially weak. With more dollars in circulation, higher U.S. inflation, and no indication yet of tighter monetary policy, a big downside move in the dollar could be one of the biggest risks for investors. Between 2002 and 2008 the dollar declined 40%, a move few could contemplate today, and one that would likely coincide with a resurgence in foreign equities relative to the U.S.

After 13 Years Dollar Turn Catalyst for Foreign Equities

Fed Quantitative Easing Bearish for Dollar

Eurozone PMI Record High Stronger than U.S.

Emerging Markets Stocks Consolidated for 12 Years

Inflation Outlook Indicators Extreme

Inflation outlook indicators reached 91.7 for May, the highest reading since 1979. This is a simple, yet effective model designed to predict the next move in CPI inflation using leading indicators like economic activity, commodities, price indices, and the dollar. In the 6 prior readings over 80 since 1950, CPI continued higher in every case. There is no prediction on magnitude, but while these indicators are up, CPI is likely to continue higher. This has been the case since we wrote about it in February when CPI was just 1.7% vs. 4.2% in April and 4.7% expected for May. The Fed and most investors expect a reversion lower after the COVID economy reopening. Last week, Treasury Secretary (and former Fed Chairman) Janet Yellen conceded that inflation readings would likely stay elevated at least through the end of this year, which begs the question of when we will know which path is correct – reversion back to 2% or sustained higher readings. The Citi Inflation Surprise Index reached a record 70.7 in May, indicating data is surprising analysts to the upside despite the constant media attention on inflation. Food prices are up 40% Y/Y, adding to the upside pressure (although both of these are just coincident, not leading, indicators). The implications of further upside in inflation are bullish for commodities and equities, but negative for long-term bonds. Higher inflation without the Fed hiking rates means real rates (rates less inflation) are more negative and stimulative for the economy. Inflation outlook indicators will be our best guide, but either way the Fed will hike rates eventually–it is just a matter of time.

Inflation Outlook Extreme: 3-5% Inflation Ahead

Inflation has Surprised to the Upside: Record High Citi Inflation Surprise Index

Surging Food Prices Contributing to Inflation

Investor Positioning Extreme

Equity investor positioning remains extreme, with 7 of 10 groups in the top quintile. Historically, this level of investor enthusiasm translated into lower returns ahead during this period of the year, since it means less cash on the sidelines to fuel stocks higher. In the 3 prior cases since 2010, the S&P 500 declined 5-16% over the following 3 months, resulting in more neutral positioning before the next move higher.

Equity Investor Positioning Extreme 7 of 10 Groups Extreme

Investor Positioning Extreme: 3 Comps in April/May followed by 6-15% Declines

Summary

Although the bullish U.S. equity conditions have deteriorated, foreign equities have reached a relative return inflection point. The Dollar Index is already down 10% from the 2020 peak and the outlook remains negative while the Fed is the most dovish central bank in the world. A further decline in the dollar will favor foreign equities over U.S. equities for the first time in 13 years, particularly as foreign economies gain momentum. The negative seasonal period of the year combined with extreme investor positioning is good reason to expect more mixed S&P 500 returns ahead as recent stock market gains are consolidated. We will continue questioning assumptions and watching our indicators every day. Thank you for your support and please contact your advisor with any questions.

 

IMPORTANT DISCLOSURES

This review and outlook report (this “Report”) is for informational, illustration and discussion purposes only and is not intended to be, nor should it be construed as, financial, legal, tax or investment advice, of Brenton Point Wealth Advisors LLC or any of its affiliates (“Brenton Point”). This Report does not take into account the investment objectives, financial situation, restrictions, particular needs or financial, legal or tax situation of any particular person and should not be viewed as addressing any recipient’s particular investment needs. Recipients should consider the information contained in this Report as only a single factor in making an investment decision and should not rely solely on investment recommendations contained herein, if any, as a substitution for the exercise of independent judgment of the merits and risks of investments.
This material is based upon information obtained from various sources that Brenton Point believes to be reliable, but Brenton Point makes no representation or warranty with respect to the accuracy or completeness of such information. Views expressed herein are current only as of the date indicated and are subject to change without notice.
This Report contains certain forward looking statements opinions, estimates, projections, assessments and other views (collectively “Statements”). These Statements are subject to a number of assumptions, risks and uncertainties which may cause actual results, performance or achievements to be materially different from future results, performance or achievements expressed or implied by these forward looking statements and projections. Brenton Point makes no representations as to the reasonableness of such assumptions or the likelihood that such assumptions will coincide with actual events and this information should not be relied upon for that purpose. Changes in such assumptions could produce materially different results. Past performance is not a guarantee or indication of future results, and no representation or warranty, express or implied, is made regarding future performance of any financial instrument mentioned in this Report.
Any benchmark shown herein is shown for illustrative purposes only. No index benchmark is available for direct investment. It may not be possible to replicate the returns of any index, as the index may not include any trading commissions and costs or fees, may assume the reinvestment of income, and may have investment objectives, use trading strategies, or have other materials characteristics, such as credit exposure or volatility, that do not make it suitable for a particular person. This is not an offer or solicitation for the purchase or sale of any security, investment, or other product and should not be construed as such. References to specific financial instruments and to certain indices are for illustrative purposes only and provided for the purpose of making general market data available as a point of reference only; they are not intended to be, and should not be interpreted as recommendations to purchase or sell such securities. Investing in securities and other financial products entails certain risks, including the possible loss of the entire principal amount invested, as the value of investment can go down as well as up. You should obtain advice from your tax, financial, legal, and other advisors and only make investment decisions on the basis of your own objectives, experience, and resources.
Brenton Point accepts no liability for any loss (whether direct, indirect or consequential) occasioned to any person acting or refraining from action as a result of any material contained in or derived from this Report, except to the extent (but only to the extent) that such liability may not be waived, modified or limited under applicable law.
This Report may provide addresses of, or contain hyperlinks to, Internet websites. Brenton Point has not reviewed the linked Internet website of any third party and takes no responsibility for the contents thereof. Each such address or hyperlink is provided solely for your convenience and information, and the content of linked third party websites is not in any way incorporated herein. Recipients who choose to access such third-party websites or follow such hyperlinks do so at their own risk.
All marks referenced herein are the property of their respective owners. This Report is licensed for non-commercial use only, and may not be reproduced, distributed, forwarded, posted, published, transmitted, uploaded or otherwise made available to others for commercial purposes, including to individuals within an institution, without written authorization from Brenton Point.
Source of data and performance statistics: Bloomberg L.P. and Factset Research Systems Inc.
©Brenton Point Wealth Advisors LLC 2021

Brenton Point - Careers

Michael Schaus

Director of Market Research

Michael Schaus is the Director of Market Research for Brenton Point Wealth Advisors and Zweig-DiMenna. Since joining Zweig-DiMenna in 1992, his focus has been on macroeconomic research, the analysis of…

READ MORE

Check out our services!

Services

Sign up!

Sign up for our monthly newsletter and get the lastest news and research from our esteemed advisors here at Brenton point. Right into your inbox!