Time to start foraging for foreign stocks as dollar declines

Still catching up after the pandemic, vacationing Americans are streaming onto foreign shores in record numbers this summer. Maybe they should check out some cheap international stocks in between beach and museum visits.

Or at least tell their advisors to start looking abroad for deals as the U.S. dollar declines.  

The S&P 500 Index finished the first half of 2023 up a healthy 16%, biting back a sizable chunk of last year’s bear market losses. Even more impressive was the technology-heavy Nasdaq Composite Index’s gain of almost 32% through the end of June.

It’s enough to make an investor cheer “USA! USA!” especially when compared to the pan-European Stoxx 600 index, which ended up roughly 8.8% over the first six months of this year, currency adjustments aside.

(Unless, of course, investors check out Japan’s Nikkei 225 jump of 27.19% in the first half, its best six-month performance to start the year since 2013, when it rose 31.57%.)

A lot of the gains in U.S. stocks have been attributed to the decline in inflation. After peaking at 9.1% for the 12-month period ending in June 2022, inflation (as measured by the consumer price index) dropped to 3% for the 12-month period ended in June.

That decline in the CPI has also signaled to the market that the Federal Reserve may be done with its series of rate hikes, which in turn will weaken the dollar. The dollar tends to rise with rate hikes as investors move to dollar-denominated investments, such as Treasury bonds, to take advantage of rising interest rates.

The dollar, which strengthened against its G-10 peers through much of the central bank’s aggressive rate hiking cycle, has lost ground to nearly every other currency since early November. David Bailin, CIO of Citi Global Wealth, sees the dollar’s relative weakening as a tailwind for foreign stocks through the rest of the third quarter and into the end of the year.

“If the dollar comes down, then you get a double bonus for investing offshore. You get foreign currency appreciation. And you get the benefit of the fact that those stocks are incredibly cheap,” Bailin said. “The combination of getting back into equities now, and doing so outside of the U.S., is an incredibly powerful one because markets today are looking to what's going to happen in 2024. And I don't think people realize that we're going to be in a true recovery then.”

And what about the big-cap tech stocks that have fueled the rally in U.S. indexes? Bailin says those investors who prefer to stay home with their stock picks may want to look beyond those pricey shares.

“For us, there are plenty of U.S. stocks trading at 13 to 15 times earnings in industries that we like that are simply not getting the attention they deserve when the equity market broadens out,” he said.

On the topic of valuations, Joe Taiber, managing partner of Taiko, a boutique, full-service OCIO solution that serves RIAs and financial institutions, says they are certainly favoring international stocks relative to U.S. stocks. However, he views them as a poor indicator from a timing perspective.

“While a weak U.S. dollar would certainly act as a tailwind to non-U.S. equities, we hesitate to have that underpin a bullish view on foreign stocks currently given the broader economic and persistent inflation risks we see over the next 18 months,” Taiber said. “If a mild recession does materialize, we’d expect another bout of strength in the U.S. dollar before it reverts to our longer-term view which is that it is highly overvalued and eventually set to weaken. “

Michael Rosen, managing partner and chief investment officer at Angeles Investments, said he prefers to overweight domestic stocks given their long-term profitability and stability.

“Weakness in the U.S. dollar would make non-U.S. assets relatively more attractive, and we may seek to tactically shift our allocations, but long term, U.S. companies are likely to continue to be structurally more profitable than non-U.S. companies, which will drive a structural overweight to U.S. assets,” Rosen said.

Michael Cordano, an investment adviser with Jackson Square Capital, agrees that a weaker dollar would help U.S. equities as their products become more competitive overseas — as long as it's not the result of hyperinflation.

That said, Cordano buys stocks based on a company’s fundamentals, not its geography.

“As money managers, we don't intentionally allocate to specific regions. We hold international equities based on company fundamentals,” he said. “We recently invested in ASML Holding and Novo Nordisk on that basis. It had nothing to do with the country where they were headquartered. Everything we do is company-specific.”