March 2025 Update
Diversification Shows its Worth
Markets have begun to become much more volatile over the past few weeks, especially stocks which have enjoyed such a wonderful run over the past two years. I thought it important to do a deeper dive into some of the reasons and to present to you some of our conclusions as to whether this is a shorter-term glitch or if it might instead have longer-term ramifications for markets overall.
One of the first things that has taken place, and maybe the most important, is that international markets have outperformed US markets by about 10 percentage points year-to-date. Certainly, the US has enjoyed tremendous outperformance over the last 10 to 15 years, primarily due to unmatched innovation in our technology, a strong US dollar, relatively strong economic growth compared to other countries, and our Federal Reserve’s aggressive monetary policies after the global financial crisis and the COVID-19 outbreak.
International Markets now have an advantage?
However, the tide may be turning, as several factors suggest that international markets may have several advantages over the US during the next few years.
The first of those advantages is valuation. The price to earnings (P/E) ratio in the US currently stands at around 21 times forward earnings. For comparisons sake, the MSCI EAFE P/E is 14 times forward earnings while the PE for emerging markets is 12 times forward earnings. We believe that the argument can be made that you certainly have more P/E expansion potential outside of the US given the lower starting point. U.S. companies are trading at high valuations, requiring substantial earnings growth to justify their stock prices. In contrast, the relatively lower P/E multiples in Europe and emerging markets provide room for both earnings growth and multiple expansion, offering additional upside potential. This is especially true if the US economy were to slow significantly, or Europe’s or Asia’s economic growth were to surprise to the upside.
Source: FactSet, MSCI, Standard & Poor’s, J.P. Morgan Asset Management. (Left) Next 12 months consensus estimates are based on pro-forma earnings and are in U.S. dollars. (Right) The purple bars for EM and China show 20-year averages due to a lack of available data. Past performance is not a reliable indicator of current and future results.
The second change is the direction of the US dollar. Our home currency has been strong for years. The phenomenon has hurt US companies that export their products by making them less competitive globally. By the same logic, the greenback’s strength has also hurt US investors who have invested money overseas, as a rising dollar decreases the value of these holdings when translated back into dollar terms.
The variables that have contributed to the recent dollar strength may be reversing. A currency’s relative strength or weakness tends to be driven by two main variables: relative economic strength (growth) and relative interest rates.
While the US growth is slowing, Europe, Japan, and even China seem to be finding some stability recently, and it has been reflected in their stock market’s returns. Japan’s Nikkei 225 recently hit multi decade highs, as companies are benefiting from reform. European markets are seeing earnings growth, despite concerns about energy. China continues to engage in significant stimulus efforts, which might lift sentiment for the overall emerging markets category.
Slowing Growth
The Federal Reserve’s rate hikes over the past couple of years have had their intended effect. But combating inflation comes with a cost, that of slower growth. Many economists now expect US GDP to be in the 1% - 2% real range for 2025. Trump’s tariffs continue to take a toll on growth and confidence. This has led to slower consumer spending, with rising credit card delinquencies and slowing discretionary spending. The labor market is showing some signs of softening and there is even talk of corporate earnings growth and margins peaking.
What is an investor to do?
Now more than ever we are advising clients to continue to build and maintain diversified portfolios. We are recommending that clients increase exposure to international markets. While we will remain underweight the international asset class when compared to our global benchmark, we believe that Europe, Japan, and select Asian economies are attractive given current valuations. We are also recommending that clients maintain exposure to emerging market equities.
From a fixed income perspective, we are recommending a shift in our opportunistic holdings, where yields are higher than US government bonds. Increasing emerging market debt could take advantage of the weaker US dollar and higher yields. We are also adding to preferred stock which earns a spread over Treasuries as well as having a longer maturity profile which should benefit in a lower interest rate environment.
Source: Bloomberg, FactSet, J.P. Morgan Credit Research, J.P. Morgan Asset Management.
We also want clients to continue to build and add to their alternative's allocation. We believe that adding to assets that have low correlations to stocks should allow clients to continue to have the possibility of positive returns, even if risk assets remain volatile in the near term. We are recommending an increase to gold exposure so that clients have some protection against inflation risk, as well as having some exposure to an asset which has historically done well in times of uncertainty. Another alternative asset class where exposure can be increased is long/short equity hedge funds. The hedged piece could help in a down market, while the increased volatility may provide more opportunities for active managers. While we do not believe that the era of US dominance is over, we want our investors to take advantage of better valuations, lower correlated, assets, and opportunistic fixed income in order to make sure they are properly prepared for the near term. We expect volatility in global markets. While we expect volatility in markets, we believe that the coming years will require a more global approach to investing, and we will begin to moving clients in that direction over the next few months.
Source: Bloomberg, Burgiss, HFRI, NCREIF, Standard & Poor’s, FactSet, J.P. Morgan Asset Management. The alternatives allocation includes hedge funds, real estate, and private equity, with each receiving an equal weight. Portfolios are rebalanced at the start of the year. Equities are represented by the S&P 500 Total Return Index. Bonds are represented by the Bloomberg U.S. Aggregate Total Return Index. Volatility is calculated as the annualized standard deviation of quarterly returns.
Ongoing Communication
We will continue to monitor this fluid situation closely in the weeks ahead, making changes to our recommendations, if warranted. We always want to offer perspective about markets and also talk about history, thus allowing us to not overreact or underreact to the current environment.
Elyxium Wealth LLC (“the FIRM ”) is a registered investment adviser located in Beverly Hills, California. The FIRM may only transact business in those states in which it is registered, or qualifies for an exemption or exclusion from registration requirements.
This presentation is limited to the dissemination of general information regarding the FIRM’s investment advisory services. Accordingly, the information in this presentation should not be construed, in any manner whatsoever, as a substitute for personalized individual advice from the FIRM. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Any client examples were hypothetical and used to demonstrate a concept.
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