Go international with ETFs

• International stocks outperformed the U.S. in the past 12 months¹, suggesting now may be an opportune time for advisors to revisit their clients’ overseas allocations.
• We presently have a tactical preference for emerging market (EM) equities based on stronger growth trends, a likely peak in EM rates, and attractive valuations.
• International ETFs can provide advisors a simple way to diversify client portfolios and expose them to potential long-term growth opportunities overseas.

Consistent outperformance by U.S. stocks from 2009-2021² may have made international stocks a hard sell to clients in recent years. But nothing lasts forever: International stocks outperformed the U.S. in the past 12 months on a total return basis³, and several factors suggest this may be an opportune time for advisors to revisit clients’ exposure to global equities.

Strong first-quarter inflows into international equity ETFs may reflect renewed investor interest in the asset class, with more than $6 billion of net inflows into broad emerging market ETFs, $9 billion into international developed ETFs and another $1 billion into single country ETFs.⁴

The good news is we believe this could be the “early innings” of an extended cycle of potential international outperformance, based on current valuations and historical trends. Despite lagging in recent years, when you look historically: in the last 50 years, international stocks outperformed U.S. stocks in over 40% of all 10-year rolling time periods.⁵

The economic restart in China, a weaker U.S. dollar, and the potential for loosening monetary policies in emerging markets all buttress the idea of going global, as detailed below. But perhaps the most critical reason for advisors to consider increasing clients’ exposure to international equities is the fact U.S. investors may be overweight domestic stocks, and mega-cap tech names in particular.

The average advisor portfolio had 77% of clients’ equity allocation in domestic stocks as of the end of 2022.⁶ Preference for U.S. stocks were 70% in 2018 and vs. a 60.5% weighting for U.S. stocks in the MSCI All Country World Index, suggesting the average advisor portfolio may be "overweight" U.S. relative to the global benchmark.⁷

This home-country bias is not limited to U.S. investors, but the concentration risk of the U.S. market is a particularly American phenomenon. Consider:

• As of March 31, 2023, Information Technology (IT) represented 26% of the S&P 500’s market cap, and three of the index’s four-largest stocks were in the sector: Apple, Microsoft and Nvidia.⁸
• Six mega-cap stocks comprise approximately 23% of the market-cap of the S&P 500 as of April 30, 2023, up from 10% in 2015.⁹

This combination of overweight allocations to a concentrated basket of domestic stocks means some advisors – and their clients – may be suffering from a false sense of diversification. Couple this with projections for international economies to potentially continue growing their share of global GDP -- and adding to international allocations is arguably more important than ever. (Read more about BlackRock Fundamental Equities portfolio managers’ views on offshore markets.)

We presently have a tactical preference for emerging market equities for the following reasons:

China’s lifting of COVID restrictions in December has led to a boost in activity in the world’s second-largest economy. China’s reopening not only benefits the domestic Chinese economy, but also boosts the broad EM region with a potential strong pick up in travel and consumption abroad. Notably, we are neutral on China over the long-term, citing challenging demographic dynamics and mounting geopolitical tensions.

We believe the dollar has likely peaked for the cycle, with the Federal Reserve having paused its tightening cycle amid slower U.S. economic growth and tighter financial conditions. A weaker dollar has historically been associated with strong international equity performance because a weaker dollar means more purchasing power for local consumers around the world.¹⁰ Emerging market economies with dollar-denominated debt typically benefit most from a weaker U.S. dollar.

Inflation in most emerging markets remains contained relative to developed economies, allowing local policymakers more leeway to provide monetary support. For example, China announced a surprise reserve requirement ratio (RRR) cut in March and lowered rates on loans issued by state-controlled banks in June.^11,12 By contrast, Fed Chair Jerome Powell told Congress on June 21, “the process of getting inflation back down to 2% has a long way to go” – suggesting more Fed tightening may be in the offing; meanwhile, the European Central Bank raised rates at its June 15 policy meeting.^13,14

In 2022, emerging market stocks -- as measured by the MSCI Emerging Markets Index -- traded close to price-to-book and price-to-earnings levels seen during the 2008-2009 Global Financial Crisis.¹⁵ Even after a strong start to 2023, international stocks were trading at a 38% discount to U.S. equities as of March 31, 2023.¹⁶

Investors looking for exposure to overseas markets have a wide range of tools to choose from. And while many advisors have historically sought the expertise of active managers with local expertise, index strategies can add value too.In fact, over the last 10 years, the S&P international index outperformed 87% of international mutual funds.¹⁷

International ETFs can provide advisors a simple, low-cost and tax-efficient way to help clients diversify portfolios, and gain exposure to potential long-term growth opportunities overseas.