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Fishing in a Bigger Pond

Avid anglers know that fishing in neighborhood ponds will result in catching as much as a half dozen bass per hour. On lakes and larger bodies of water, it becomes more challenging. Whether it is fishing from ponds or lakes, a host of factors influences the success of the catch, including the time of the year, water temperature, most dominant prey, currents, depth, vegetation, and type of lures, to name a few. The consensus view is that it is easier to catch fish from your neighborhood ponds than in unfamiliar lakes or large bodies of water.

Most investors are familiar and comfortable with investing in their local markets (i.e., U.S. equities versus international equities). Familiarity breeds comfort. Familiarity is what we are used to. Comfort is if it feels good. Whether it is familiarity or comfort, humans and hence investors are creatures of habit. Investors are often set in their ways and are resistant to change.

We witnessed some of the largest declines last year during the height of the COVID-19 pandemic in Emerging Markets and Developed International equities. Investors turning to the safety of the large-cap US equities. However, the sharp recoveries from the March 2020 lows in Emerging Markets such as Chinese equities reinforce the global reflation/recovery trade. Most importantly, it hints at global investors beginning to seek out investment opportunities outside their comfort zone.

2021 may be the year for international investments. After a decade of U.S. stocks outperforming foreign stocks, there are technical signs to suggest a rotation into international equities.

For example, many developed and emerging markets are currently outperforming domestic equities in 2021. So far, Chinese equities (FXI +10.77% YTD) has a decisive lead over US equities (SPX +3.40%). See the attached chart showing the YTD performance chart for international equity ETFs.

The Relative Rotation Graph (RRG) study also hint of technical strength in international indexes. Many foreign market indexes continue to retain their relative leadership roles as represented by their positions within the Leading Quadrant. US equities (S&P 500 Index) continue to struggle within the Lagging Quadrant, suggesting relative underperformance over the past eight weeks. If the above trend continues, investors will notice the relative discrepancies and begin to favor more international equities.

With the U.S. dollar continuing to weaken further, a more trade-friendly President Biden administration, the global economic landscape stabilizing and even improving, economies moving beyond the fears of deflation, and global consumer confidence improving, investors will begin to favor international equities. Although habits are hard to break, this may be the start of a multi-year rotation into foreign equities.

Within international markets, emerging markets offer the greatest long-term returns as they have been trading at relative discounts to developed equities for the past decade. Chinese equities and Chinese technology stocks are emerging to challenge US large-cap FAANG names for global leaderships. With the emergence of a large middle class in China and other parts of Asia, the emerging markets tech giants can rival the U.S. tech giants in the years ahead.

One of the negatives of the international markets remains their higher volatilities and the historically concentrated weightings in Financials, Consumer Discretionary, Industrials, Materials, and Energy. It is in sharp contrast to the U.S. stock market, which is skewed toward two dominating sectors - Technology and Communication Services. As the world becomes more global and China, India, South Korea, and other emerging markets exert more influence on global consumption, spending, savings, investing, and real estate exposure, U.S. equity centric investors must adjust their portfolios. Having exposure to international equities can help to diversify global risks, increase the overall performance of a portfolio, and at the same time reduce the concentration risk with a more balanced allocation of positions across different sectors and regions.

A brief snapshot of the iShares MSCI World (ex-USA) Index (ACWX) shows the regional exposure as Asia (44%), Europe (39%), North America (7%), Latin America (2.5%), Middle East (1.7%), and Africa (1.09%). The country exposure is Japan (16%), China (12%), UK (8.25%), France (6.5%), Canada (6.3%), Switzerland (6.2%), Germany (5.8%), Australia (4.3%), South Korea (4.2%), and Taiwan (4%). Sector exposure is Financials (16.8%), Consumer Discretionary (13.3%), Information Technology (12.2%), Industrials (11.4%), Healthcare (9.2%), Consumer Staples (8.6%), Materials (7.2%), Communication Services (6.9%), Energy (3,9%), Utilities (3.2%), and Real Estate (2.6%). The top 10 holdings by weight are INDA, TSM, BABA, Tencent Holdings Ltd, Samsung Electronics Ltd, Samsung Electronics Co Ltd, Nestle SA, Roche Holdings, Novartis, ASML Holdings NV, and LVMH Moet Hennessy Louis Vuitton SE.

A quick review of the iShares MSCI Emerging Markets ETF (EEM) shows the ETF concentrated in Asia (80%), Latin America (7.8%), Europe (4.4%), Middle East (4.2%), Africa (3.5%), and North America (0.23%). The country exposure in China (39%), South Korea (13.5%), Taiwan (12.5%), India (9.25%), Brazil (5.1%), South Africa (3.4%), Russia (2.8%), Saudi Arabia (2.4%), Thailand (1.8%), and Mexico (1.7%). The sector exposure is Information Technology (20%), Consumer Discretionary (17.8%), Financials (16%), Communication Services (11%), Materials (6.8%), Consumer Staples (5.4%), Energy (4.7%), Industrials (4.1%), Healthcare (4%), Real Estate (2%), and Utilities (1.8%). The top 10 EEM equities by weighting are TSM, BABA, Tencent Holdings LLC, Samsung Electronics Co Ltd, Meituan, Naspers Ltd, Reliance Industries, Ltd, JD, China Construction Bank, Ping An Insurance Group of China Ltd.

Source: Courtesy of

Source: Courtesy of

Source: Courtesy of

Source: Courtesy of

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