After a long outperformance by U.S. equities, the time appears to be right for investors to make a shift and add a broad exposure to international stocks to their portfolios, according to Jeffrey Kleintop, managing director and chief global investment strategist for Charles Schwab & Co.
Most investors are probably underweight international stocks in their portfolios, which is natural after a decade of underperformance, he said in an interview with ThinkAdvisor on Wednesday, suggesting they'd be mistaken to hold on or add positions in former equities leaders in hopes those stocks will be the first to rebound.
"When markets are difficult, challenging, volatile, they want to retreat back to what's been working," Kleintop said. "I think that's the wrong thinking this time. I think we've started a new environment where international stocks are where we want to focus."
Moving to new leaders in an environment with higher inflation and rising interest rates should benefit portfolios, Kleintop added. A broad exposure to international stocks should present an appealing opportunity in the second half of this year, he said.
"There's a lot of focus on whether we're going to get a recession or not globally and the market's been obsessed with that in the first half of the year," he said. "What it may have overlooked is that earnings are actually improving,"
Economists have lowered their growth outlook for most countries around the world — the Organization for Economic Cooperation and Development cut global projections Wednesday — "but at the same time we're seeing analysts raise earnings forecasts for this year and next year," he said.
That divergence between economic and earnings forecasts is atypical but may make sense in the current environment, Kleintop noted. "Some of what's causing concern about the economy, high inflation, is actually good for the private sector and profits," he said.
In his 2022 midyear outlook, released Monday, Kleintop explained that rising energy prices can pressure the economy while boosting energy company earnings. In addition, the increased business investment happening now contributes more to profits than to economic activity, he noted.
Forecasts Up, Valuations Down
Despite concerns about the economic effects of high inflation and the war in Ukraine, analysts now expect European earnings to grow by more than 13% this year, an eight percentage point boost from the start of 2022 and a faster climb than forecasts for U.S. companies, according to Kleintop, who wrote that profits may be more important than gross domestic product for share prices in this year's second half.
"If we continue to see solid earnings growth in the second half of the year, stocks may find their footing," he said in the interview.
Stock valuations in non-U.S. developed countries are well below average, at previous-recession levels, suggesting that "investors are much more pessimistic about the earnings picture than analysts are," he said. "Something will have to give in the second half of the year," with either analysts saying they were wrong or markets acknowledging they underappreciated these companies' earnings potential, he added.
"The real question is how much more aggressive will central banks be in trying to tame inflation," and how that will affect the economy and earnings, Kleintop said.
U.S. Stock Risks
Kleintop sees more risk now in U.S. stocks, which continue to trade above their 20-year average, face a less favorable fiscal and monetary policy backdrop than European and Asian equities, and are less sensitive to inflation than global and especially European equities, he said.
