- Some international stock markets may benefit more than others from the new realities caused by war and COVID.
- The war in Ukraine and the ongoing COVID pandemic are reshaping global supply chains and trade relationships and helping to slow the pace of globalization.
- Big commodity producers and exporters, such as Canada, Brazil, and Australia have benefited from reduced supplies on world markets.
- Despite these disruptions, international stocks are forecast to outperform US stocks over the next 20 years and may offer US investors attractive potential returns and portfolio diversification.
- Professional management may help US investors gain exposure to international markets while managing the risks.
Since the cold war ended in 1991, the economies of most countries around the world have grown more closely linked. Imports and exports have increased, jobs have been moved to lower-wage countries, stock prices of multi-national companies have risen and inflation has been held down. Over the past 2 years, though, policies intended to slow the spread of the COVID virus and more recently, to punish Russia for invading Ukraine have slowed the long march toward the creation of a truly global economy and global markets where US companies and investors seek opportunities anywhere in the world.
Now, as most countries emerge from the economic downturn associated with the global pandemic, a new set of challenges confronts them. These include the war in Ukraine, spiking commodity prices, and rising interest rates. As Dirk Hofschire from Fidelity's Asset Allocation Research Team puts it, "A broad set of crosswinds is creating greater differentiation among countries."
In the second half of 2022, US investors who recognize the benefits of investing internationally may want to think of the world as being made up of 3 types of economies rather than 1 global economy.
1. The winning economies
This first group includes the small number of countries and companies that have indirectly benefited from the conflict in Ukraine. The economic sanctions imposed on Russia and the violence in Ukraine itself have cut production and exports of energy, industrial commodities, and food. The big commodity producers and exporters, such as Canada, Brazil, and Australia have benefited from reduced supplies on world markets.
2. The waiting economies
The second category of countries includes the "waiting economies," countries with good long-term prospects for investors who have time to wait that are struggling temporarily with new geopolitical and economic realities. These include emerging-market (EM) countries like India and Mexico, as well as developed-market (DM) countries, particularly in Europe, which has been hard hit by the Ukraine war.
Consider emerging markets. Most economic forecasts expect that spending by consumers in EM countries such as India will be a major source of economic growth and profits for companies over the next 20 years. However, inflation is hurting the ability of lower-income consumers to spend. Inflation is pinching pocketbooks around the world, but it is especially painful for the less wealthy who may be forced to reduce spending.
COVID has weighed especially heavily on emerging-market economies. The World Bank predicts that only about one-third of EMs will recover to their pre-pandemic growth rates during the rest of this year. Still, EM stocks are expected to be the best-performing stocks over the next 20 years partly because many EMs have relatively young and growing populations whose incomes will rise as their economies grow. India, for example, already boasts a greater number of households with disposable income of more than $10,000 than does Japan. The growth of these domestic consumer markets is a key reason why Fidelity's Asset Allocation Research Team forecasts that EMs will grow to comprise about half of global gross domestic product in 20 years, compared with about 40% now and one-quarter 20 years ago.
John Dance, manager of Fidelity® Emerging Markets Fund (FEMKX), says, "EMs are increasingly the global growth engine and I'm seeking companies that take advantage of higher living standards and an expanding middle class."
The Ukraine war is harming consumers and businesses in developed markets as well as in EMs. European Union countries are suffering from high inflation, partly due to their reliance on natural gas from Russia for most of their energy. This is a particular problem for Germany, which is Europe's largest economy. As a result, businesses and consumers are struggling with higher costs and Fidelity's Asset Allocation Research Team has downgraded its outlook for Europe to reflect an increased likelihood of recession.
Bill Bower, manager of the Fidelity® Diversified International Fund (FDIVX), points out that despite the effects of the war, DMs such as Europe still offer more than just lower stock prices than the US. "They're also home to high-quality companies with some unique investment ideas, like LVMH (LVMHF), which I believe is probably the most unique luxury goods company in the world," he says. "It's important to focus on high-quality companies that are world class, wherever they may be from."
3. China: A category of its own
A third category is China, which has been relatively unaffected by the violence and sanctions in Europe and has maintained its trade and energy relationships with Russia. That insulation from the inflationary effects of energy shortages puts China in a different position than much of the rest of the world. But China is also in a different spot than most of the rest of the world due to its own policymakers' actions. While most other countries are in the mid- to late phase of the business cycle, Xiaoting Zhao, manager of Fidelity® Emerging Asia Fund (FSEAX), says that China's "first-in, first-out" experience with the initial wave of COVID put its economy on a different timetable than most others. China is emerging from a slowdown, and its government is spending and cutting interest rates to encourage economic recovery. Zhao believes that low inflation provides China's policymakers more flexibility than those elsewhere to stimulate the economy with monetary and fiscal policy.
That commitment to stimulating growth creates opportunities to invest in Chinese companies during the early stage of an expansion, which is often a good time for stocks. But the government also has an equally serious commitment to controlling COVID through mass quarantines and economic shutdowns. That raises risks for investors that growth could stall.
Wilfred Chilangwa, portfolio manager with Fidelity's Strategic Advisers LLC, says China's potential recovery is taking place within a larger economic transformation. "China has gone through a period of adjustment, remaking its economy to emphasize consumer spending over export-oriented manufacturing and there are pockets of the economy where government support provides a sort of a policy tailwind."
As China's economy recovers and grows more sophisticated, Sam Polyak, manager of Fidelity® Series Emerging Markets Opportunities Fund (FEMSX), sees opportunities in disruptive and innovative companies there. He especially favors China-listed firms that are challenging well-known premium international brands. These companies include homegrown brands such as athletic wear maker Li-Ning, which competes with Nike and Adidas, as well as companies such as appliance maker Haier that have purchased familiar US brands, such as that of General Electric household appliances.
Some of China's high-tech disruptors face disruption of their own in the second half of 2022, however. Zhao expects large, internet-focused companies to face short-term challenges from heightened regulation. Still, he says, "I continue to be bullish on the outlook of China over the medium to long run."
Fidelity® Diversified International Fund, Fidelity® Emerging Markets Fund, Fidelity® Series Emerging Markets Opportunities Fund, and Fidelity® Emerging Asia Fund held securities mentioned in this article as of their most recent holdings disclosure. For specific fund information, including holdings, please click on the fund trading symbols above.
Why bother with international stocks?
With war and COVID continuing to vex international travel, trade, supply chains, and more, it's easy to question the point of international investing. The point is that getting exposure to markets and economic growth outside the US is likely to offer long-term opportunities for return that you'd miss otherwise. Fidelity's Asset Allocation Research Team expects international stocks to outperform US stocks over the next 20 years.
In the second half of 2022, cyclically adjusted price/earnings ratios for non-US stocks are lower than those of the S&P 500®. That fact, combined with the strength of the US dollar against other major currencies, means many international stocks represent relative bargains and suggests they may offer opportunities for attractive returns as well as providing diversification for US investors' portfolios. Despite recent volatility, prices of US stocks are still relatively high compared with stocks from outside the US and so far in 2022, the US dollar has risen against most major developed-market currencies. "This combination of relatively low stock prices and a strong dollar indicate a relatively favorable long-term backdrop for non-US stocks and currencies," says Fidelity global equity strategist Seth Marks. "Commodities and energy stocks have been strong performers so far this year and stocks from places such as Canada that export commodities may continue to deliver positive returns in the second half of 2022," he says.
Old risks and new realities
The label "international stocks," is often applied to a widely variegated group of companies and countries that also face widely variegated prospects. In the second half of 2022, research and security selection, which are always important for international investors, will become even more so.
While history and currency may both be on the side of international stocks, the future is not the past and the international order may operate differently in this new era. Seemingly settled assumptions about transnational supply chains, the free movement of goods, people, and capital, trade policy and international law are all still evolving in ways that may have implications for investors. As new realities force changes to old assumptions, investment managers with strong fundamental research capabilities may be able to spot opportunities in the shifting landscape.
EMs have been defined as places where the actions of government policymakers may matter to investors at least as much as the rising and falling of the business cycle. That has meant that investing in them involved greater political, social, economic, and regulatory risks than investing in more developed markets. But in the second half of 2022, the DM and EM economies alike are being shaped by governments' management of everything from vaccine distribution to monetary and fiscal policy to relations with Russia, so EMs and DMs now may resemble each other more in this respect than they used to.
While they no longer hold a monopoly on policy risk, EM stocks are still likely to be potentially more volatile and less liquid than stocks from developed markets. But because they have not historically moved in lockstep with developed markets, they can help diversify investors' portfolios to help manage risk. Of course, diversification and asset allocation do not ensure a profit or guarantee against loss.
Some other risks inherent in international investing have been brought home to US investors over the past 2 years by an executive order barring them from owning shares in Chinese companies that the US says aid China's military and spy agencies. Fidelity geopolitical risk analyst David Bridges also points to what he describes as rising populism as another source of risk for global investing, which has benefited from the presence of market-friendly governments in many countries over the past several decades. In EMs such as Chile, Peru, and Mexico, political entrepreneurs aligned with these movements have gained power partly by promising to reverse earlier market-oriented reforms.
Investors should also keep in mind that the EM category contains a wide variety of companies operating in very dissimilar countries. The countries that are grouped within the same EM indexes may present very different opportunities—and risks—to investors. This makes both careful security selection by experienced managers and diversification within portfolios important for spotting opportunity while avoiding undue risk.
Those who want to invest outside the US can get professionally managed exposure through mutual funds, ETFs, and managed account solutions. Fidelity has a number of tools to help investors research mutual funds and ETFs including the Mutual Fund and ETF evaluators on Fidelity.com.