International Equity Update

Recently my colleague, Randall Coleman, and I participated in a chat at an Advisors Capital Management conference discussing international equity investing. Moderators included ACM Partner, Michael Lieberman, and Regional Vice President, Lee Balducci. The following summarizes a few questions and answers during this interview:

Question 1: We’ve seen a rotation into stocks outside the US in the first four months of 2025, with Europe particularly strong. What are the factors driving this? And can international equities continue to outperform the US?
Of course, it’s difficult to call short-term swings and we don’t expect non-US equities to lead every month or quarter. The timing and certainly the magnitude of this rotation, thus far in 2025, surprised us. That said, as many of you know, we’ve highlighted the significant valuation disparity between US and foreign stocks and how, looking at history, this suggested there needed to be a reversion to the mean. Although closing some, a notable valuation gap still exists, with foreign equities trading at more than a 50 percent discount on a price-to-book basis and 30 percent discount on a price-to-earnings basis. We look for these spreads to continue to narrow over time, but again, not in a straight line. This should be driven by improving economic fundamentals in Europe and Japan, which we believe portends a valuation rerating in these markets.

Contributing to the recent performance, fund flows and ETF data suggest a worldwide reassessment of portfolio positioning by both domestic and foreign investors, as they’ve come to realize they’re too concentrated in US stocks. One of the unintended consequences of the new tariff regime relates to lower confidence and trust in America by foreigners. This resulted in increased money flows to non-US equities, probably mostly through international equities garnering a bigger share of new investment dollars.

Another factor benefiting foreign equities year-to-date includes the weakening dollar. Approximately half of the nearly 1400 basis point performance advantage in the first four months of the year for non-US equities was due to US dollar weakness. There is still overvaluation of the US dollar against several major currencies, but we don’t look for the greenback to enter into a free-fall, and believe foreign equities will not get this kind of boost from the weakening dollar on a sustained basis. The greenback may still lose ground over the coming years, but it should be at a much more gradual pace.

Finally, the S&P 500’s heavy concentration in the Magnificent Seven turned out to be a negative for US equities in the first four months of 2025, especially by constituent Tesla, which dropped more than 30%. We’ve seen a recovery in these names thus far in May, but tariff uncertainty may continue to have an outsized impact on these behemoths as well as the Information Technology sector. Many technology companies like Apple, for instance, seem inextricably linked to geopolitics to a degree not seen before, and this may not change for some time. Ergo, Information Technology’s larger weight in the S&P 500, especially from hardware names, may make this index more volatile going forward. We note President Trump generally views global supply chains as bad, especially those that flow through China or countries that extend China’s manufacturing base. This administration prioritizes the reshoring of manufacturing to the US, or at least, having the US be the primary supply chain hub. The success and extent of this policy remains uncertain, but we think we’ll continue to see fracturing of existing supply chains for many industries, especially semiconductors.

Question 2: How have global tariffs changed your thinking about your country and individual stock allocations?
As you know final tariff rates for most of the US trading partners remain unknown. However, as we wrote in a recent commentary, Tariff Trauma, countries with greater US trade dependence for their economic growth will probably make faster trade deals. This includes countries like Vietnam and Canada. On the other hand, those countries and regions with more diversified economies, less dependence on US trade, like Europe and China, will likely see more extended trade negotiations. Generally, we don’t make specific predictions on where tariffs rates will end up, as this enters the realm of the unknowable. Also, our international investment process doesn’t typically start with top-down. We focus on high-quality, competitively-advantaged businesses and look for mispriced opportunities, mispriced risks, or when the market’s selling pressure has been indiscriminate with investors not considering company-specific factors. With most of our companies able to generate positive free cash flow in any kind of economic climate short of depression, we think we will weather this new tariff world better than most.

That said, we review how our individual company investments will do in different scenarios. We ask what is the nature of the tariff exposure for a given company? And do we have too much exposure to any specific risk factor? With tariffs, there is the direct impact from the higher cost of the applied duty. Candidly, this is not our primary concern. We believe our portfolios will withstand this direct tariff effect fairly well since most of our companies have higher profit margins and greater pricing power. These companies can pass through the higher costs to customers and protect their margins. Tariffs for intermediate materials are an increase in the cost of goods sold, and thus, companies with lower profit margins will suffer disproportionately compared to more profitable companies.

A more important aspect, however, would be market share loss and confidence effects. An extreme example of market share loss would be a China supplier with 100% of their sales to the US. This hypothetical company probably doesn’t exist, but toy makers, electronics, and appliance makers in China can have significant exposure to the US. Obviously, they will lose market share if these tariffs against China are maintained. The confidence or second order tariff effects can also be very impactful. These are typically companies producing capital goods lasting for years. The current state of uncertainty in many cases effectively froze company spending for these kinds of capital expenditures. Thus, we have to monitor to make sure the portfolio is not too exposed to this risk factor. With some of our newer holdings we expect the investment themes to be more impervious to tariffs. Also, a few existing investments should generally benefit from higher China tariffs.

Question 3: There are several significant conflicts and wars occurring worldwide. Is Europe still an ally? Can you cover some of these and what are the investment implications?
The path to peace by Russia and Ukraine remains a difficult one, as is the Gaza conflict. We’re not sure a lasting peace will ever be found in the Middle East, and although Russia and Ukraine appear willing to enter into peace talks, we think President Putin wants to put the USSR back together again. We believe Europe is still an ally, given we share a similar government structure with an emphasis on individual freedoms, but the relationship will not be business as usual. One aspect of change includes Europe’s greater military aspirations, with less dependence on the US and NATO. President Trump’s urging Europe to take greater defense responsibility. Russian aggression makes this a priority, as recently communicated by German Chancellor Merz’s acceptance speech. Germany’s commitment to spend one trillion euros over the next decade for defense and infrastructure, giving the government unlimited spending authority to build military capability should provide a boost to the German and European economy, as Germany remains the biggest trading partner for all of Europe. Tariffs will have a more immediate negative impact, but this fiscal spending package, while providing a deferred boost, will be much more significant, dwarfing the tariff headwind. One important ramification of this development will be faster growth for many European defense companies, as they gain market share in meeting Europe’s military needs. This entered into our thinking with the addition of MTU Aero last year and Saab more recently.

Question 4: Why invest in International? Why now?
I think the reason remains the same, that being diversification from US equities. But recent developments suggest this to be even more important now as the world increasingly moves toward three major trade blocks: North America led by the US, Europe led by Germany, and Asia led by China. There are international equity opportunities not available in the US, and we can build a portfolio of high-quality companies with a sustainable competitive advantage, trading at significant discounts to their intrinsic value.

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