Jeffrey Kleintop, Chief Global Investment Strategist, Charles Schwab & Co, joined Keith Black, Managing Director of RIA Channel, to discuss international equity markets during times of geopolitical risk.
While geopolitics is an ever-present part of investing, it typically doesn’t have a significant market impact unless a recession ensues. The key transmission mechanism from geopolitical events to recessionary markets is through increased oil prices. To date, wars in Europe and the Middle East have not had enough of an impact on commodity prices to cause a recession.
Kleintop notes that close links between economies can lead to globally synchronized business cycles. Currently, he believes that the global economy is in a cardboard box recession, where countries most dependent on manufacturing and trade, such as Germany and Japan, are in an economic downturn. Service-oriented economies like the US are experiencing more robust economic growth. Inflation remains an issue in the US, while the European Central Bank is much closer to a victory over inflation.
The Chinese economy is more likely to impact global markets than any issues arising from geopolitical developments. The economic weakness in China is focused on the overleveraged property developers. Chinese consumers may be hit especially hard if the developers are unable to deliver the promised new homes after the buyers deposited down payments of 30% to 50% of the housing cost before construction even started. The critical question for the global economy is how much Chinese consumers will spend on US brands and European luxury goods. Many US companies, including Nike, Skechers, and GM, earn 25% to 50% of their revenues in China.
Now might be the time for investors to overcome home country bias and increase their holdings of international stocks which have stronger cash flows and higher dividend yields than US stocks. While economic growth is much stronger in the US than in the rest of the world, the average international stock is outperforming the average US stock on an equal-weighted basis. Kleintop predicts that the value of the US dollar can weaken over the next several years, which could give a potential tailwind to the performance of international stocks.
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