How Will International Stocks Perform in 2018?

What to Expect in 2018 and Beyond

The global stock markets have been strong performers moving into 2018, with the Vanguard MSCI EAFE ETF (NYSE: VEA) rising more than 20 percent in 2017. While economic growth rates have been healthy, some investors are concerned over lofty valuations in the United States and the many political risks abound. The upshot is that most international investors believe that the economy is more resilient than in past years and diversification can stave off many risks.

Broad Growth Worldwide

The global economy is experiencing unusually broad and synchronous growth rates heading into 2018, according to the OEDC’s Economic Outlook. While every single one of the world’s 45 major economies grew in 2017 and is expected to grow in 2018, annual growth rates remain below pre-crisis period and that of past recoveries. Longer-term challenges have inhibited stronger, more inclusive, and more resilient economies.

Employment rates in many OEDC economies are above pre-crisis levels, but these trends haven’t produced real wage gains, as of early 2018. Without wage growth and inflation, the OEDC believes that growth across these countries will weaken in 2019. There are also high levels or corporate and household debt created by low interest rate environments, which raises questions about the sustainability of growth over the coming years.

The OEDC forecast slower growth rates in 2019 for most countries, but India was an important exception. The group forecast that India grew at 6.7 percent in 2017 and will pick up to 7 percent in 2018 and then 7.4 percent in 2019. These trends are driven by reforms that are expected to boost investment, productivity, and growth. Brazil and Russia are also expected to exit their recessions, while the United States will slow to 2.1 percent in 2019.

Low Correlation and Volatility

Global stock market correlations have returned to more normalized levels after reaching record high correlations following the 2008 financial crisis. In fact, equity correlations are the lowest that they’ve been in over 20 years across the G20. For instance, the U.S. stock market has been a strong performer, which European stocks have been trading at a growing discount, despite favorable macroeconomic conditions, cheaper valuations, and a lower currency valuation.

At the same time, volatility has remained low across many global stock markets. The Chicago Board Options Exchange (CBOE) volatility index has trended below 10.0 in at year end, which is less than half of its long-term 20.0 average in the United States. It’s worth noting that some of the low volatility may be attributable to sector-related variance, which means that the low headline number may be masking declines in some sectors.

The risk of political, central bank, and military threats haven’t disappeared, but investors believe that the global economy isn’t as exposed to these problems as it was in the past. A conflict with North Korea could have a big impact on the markets, if it occurs, but a bigger risk may be central bank tightening without inflation, which could lead to slower growth and other issues that could lead to problems for equity and bond markets.

Tips for Investors

The low correlations between global equity markets means that international investors may benefit from diversification. After all, they could benefit from less volatility in their portfolio without sacrificing returns given the broad economic growth worldwide. Diversification may also be a smart move if the global economy experiences a near-term recession from depressed wages or the potential for a debt-related financial shock.

Investors should also ensure that they rebalance their portfolio on a regular basis. For example, the strong U.S. stock market performance means that many international investors could be overexposed to U.S. stocks at the end of 2017. Shifting more assets into European stocks could benefit them if valuations even out between the U.S. and Europe. The added benefit is that the portfolio is better diversified in the event of a global downturn.

The best way to invest evenly across global markets is using international exchange-traded funds (ETFs) or mutual funds that maintain asset allocations automatically. For example, the Vanguard MSCI EAFE ETF (NYSE: VEA) provides exposure to non-U.S assets, including 54 percent exposure to Europe, 38 percent exposure to Asia, and eight percent exposure to non-U.S. North American markets, such as Canada and Mexico.