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Wednesday, February 22, 2017

Financial Focus - Are U.S. Stocks the Only Game in Town?

The gravitational pull from Washington D.C. has kept nearly all of the recent focus on the United States. President Trump's proposed policies have raised the enthusiasm level of traders and investors around potential domestic growth, and the U.S. stock market has responded by moving to new all-time highs again last week.
Perhaps a bit lost in investors' recent focus is the investment news from abroad, where the data have been rather promising of late.  With international investments having underperformed in recent years, healthier global trends could support better performance from foreign markets, consistent with our view of the current benefits of global diversification. Consider the following perspectives:   

Economic trends have perked up – The underpinnings of international advanced economies have shown encouraging improvement in recent months. Several measures across Europe and Japan are consistent with moderate but broad-based economic improvement, including the Eurozone manufacturing PMI index, which has surged to multiyear highs, having risen for five straight months.  PMI readings in Japan have risen as well, posting four consecutive months above the level that denotes expansionary activity. PMI trends are typically closely related to economic growth trends. Credit demand in the euro area, where lending activity to consumers and businesses has risen fairly steadily since mid-2016. Inflation, which is firming slightly abroad, including a pickup in consumer prices in the euro area, a welcome sign given several months of deflationary pressure this time last year. In Japan – a market that has struggled to achieve healthy inflation for years – prices have risen modestly for the last three months after six straight months of declines. Japan's unemployment rate, now at 3.1%, is at the lowest level since 1995. Eurozone unemployment, while still far too high, has dropped for 14 consecutive months from 12.1% to 9.7%. However, improvement has not been confined to developed economies. Trends in China have been positive as well, including rising manufacturing and non-manufacturing PMI indexes, and a recent rebound in both import and export growth. International economic data has been encouraging recently, but we view this as a good start: Growth has not hit its stride.  We don't expect growth in the European and Japanese economies to outpace the U.S. We believe the domestic economy is on much firmer footing. However, international developed economies are starting from a lower base, and we think the trajectory of improvement, not simply a comparison of headline GDP figures, can be a favorable driver for global markets. 

Economic tailwinds will meet policy risks – Green shoots of economic improvement are a good sign, but the key will be sustained growth. We think there are a few economic drivers that should provide ongoing help. Examples include

Monetary policy stimulus – The Federal Reserve is in the very early stages of a slow move toward more normal interest rate policy, where we expect it to withdraw stimulus slowly, including a few rates hikes this year. However, central banks around the world, including the European Central Bank and the Bank of Japan, are likely to continue to pursue highly expansionary policies to promote growth in those regions.

Currency benefits – The alternate effect of the strong U.S. dollar has been a weakening of currencies such as the euro and the yen. This in turn should provide support to export activity in these economies, which in many cases have GDP that is more sensitive to exports than the U.S. 
The global environment won't be devoid of risks, with political uncertainties likely to grab the spotlight this year. Upcoming elections in Europe (Germany, France, the Netherlands) raise geopolitical risks to the extent that populism continues to influence election outcomes. Additionally, the execution of the U.K. withdrawing from the European Union (Brexit) will begin relatively soon, injecting additional uncertainty into the international outlook.  Looking for better performance – International markets have underperformed the S&P 500 over the past several years, with U.S. large-caps posting a return of 14.8% per year since the beginning of 2013, compared with 5.2% for EAFE (international developed-market large-cap stocks) and -0.5% for emerging markets.
The trends mentioned above have shown up in better international performance recently, with EAFE and emerging markets outpacing the S&P 500 since November.  Given the visibility and prominence of potentially faster U.S. growth combined with head fakes of an economic rebound abroad over the past few years, ongoing economic improvement is likely needed to drive sustained strong performance internationally.  We think international large-cap equities represent an opportunity today, supported by more attractive valuations (EAFE is trading near 14 times earnings versus 17 times for the S&P 500), the prospects of further economic improvement, and a potential earnings rebound.

This article was written by Edward Jones for use by your local Edward Jones Financial Advisor, which in Prescott is Neal Robinson at 1400 N. Acres Dr. Suite 55

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