asset allocation | FEBRUARY 21, 2023
A Long-Awaited Reversal
Near-term tailwinds could favor international markets.
After more than a decade of U.S. equity returns outpacing those for the rest of the world, 2022 brought a long-awaited reversal. During the nine years between 2013 and 2021, U.S. equities outpaced the rest of the world by 170%, cumulatively, as measured by the MSCI indices. However, that difference narrowed significantly in 2022, and now stands at only 115%.
This pivot has many investors asking what has driven the reversal, and whether we should expect more of the same in 2023.
Chinese Economy Poised to Accelerate
The most notable change has come from China. While China continues to face a challenging health care situation due to the spread of COVID-19, the recent relaxation of COVID-driven restrictions means economic activity is poised to increase considerably in 2023. Additionally, economic activity is likely to enjoy a further boost from the increased use of credit over the past year—which typically has a strong lagged effect on the economy.
Energy Crisis Averted?
Another notable driver of this change is that the outlook for European economic growth has been greatly improved by an unusually warm winter. Due to the impacts of the war in Ukraine and related gas pipeline disruptions, widespread power shortages were expected to significantly curtail European activity this winter. However, the relatively warm winter weather and an increase in imported liquified natural gas from abroad allowed storage levels to rebound from dangerously low levels in April to nearly full levels by year-end. This sharp improvement has caused energy prices to fall significantly and means that industrial activity in most of Europe has remained unaffected by energy supply concerns.
Still, it is important to note that an energy crisis may not be fully averted, as the outlook remains somewhat uncertain due to the ongoing war, and the 2023-2024 winter may ultimately bring more challenging weather conditions. Nonetheless, the relief from energy concerns combined with the expected boost in demand from China means the near-term outlook has improved considerably.
Weakening U.S. Dollar
Lastly, the U.S. dollar has begun to fade after strengthening sharply in 2021 and most of 2022. And this trend may hold over the near term as the two most potent drivers of currency strength—interest rate differentials and economic growth differentials—appear likely to favor a further weakening of the dollar.
Interest rate differentials are poised to narrow because the U.S. Federal Reserve is likely to shift to a more dovish stance sooner than other major central banks. Meanwhile, economic growth differentials may narrow further due to the improved outlooks for China and Europe.
In conclusion, 2022 brought a notable shift in performance trends between U.S. equities and those in the rest of the world—and the drivers of these trends may remain in place over the near term. As a result, T. Rowe Price’s Asset Allocation Committee is maintaining an overweight position in non-U.S. equities relative to U.S. equities.
After nearly a decade of outperformance, U.S. equities trailed the rest of the world in 2022, and many wonder if this shift in performance will continue in 2023.
In our view, improved economic outlooks in China and Europe, coupled with a weaker U.S. dollar, may favor international markets in the near term.
For the nine years from 2013 through 2021, MSCI indices show that U.S. equities outpaced the rest of the world by 170%, cumulatively. However, the cumulative U.S. equity outperformance significantly narrowed in 2022 to 115% (Figure 1). Many investors are wondering what has driven this shift and if the trend is likely to continue in 2023.
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U.S. Equity Performance Versus the Rest of the World
(Fig. 1) Index performance: MSCI U.S. Index versus MSCI All Country World Index ex-U.S. (in local currency)
January 31, 2013 through December 31, 2022.
Past performance is not a reliable indicator of future performance.
Sources: T. Rowe Price analysis using data from FactSet Research Systems Inc. All rights reserved. MSCI data. See Additional Disclosures.
Notably, improved economic outlooks in China and Europe appear to favor non-U.S. equites. After the recent relaxation of COVID-related restrictions in China, we believe economic activity there is poised to increase significantly in 2023. Increased credit use by Chinese borrowers—which historically has had a strong lagged effect on the country’s economy—is also likely to boost reported activity.
In Europe, natural gas supply disruptions caused by Russia’s invasion of Ukraine were expected to cause widespread power shortages and significantly curtail economic activity during the winter. However, relatively warm weather, coupled with imports of liquefied natural gas, allowed storage levels to rebound to nearly full levels by year-end. So far, industrial activity in Europe has largely remained unaffected, and the region’s near-term growth outlook has improved considerably. An expected recovery in demand from China should also be beneficial.
A Weaker U.S. Dollar
(Fig. 2) U.S. Dollar Index
10 years ended January 23, 2023.
Past performance is not a reliable indicator of future performance.
Source: Bloomberg Finance L.P.
Meanwhile, the strong U.S. dollar has begun to fade—a weaker dollar is typically supportive for non-U.S. stocks as it tends to increase the dollar value of dividends earned in foreign currencies. We believe the dollar is likely to weaken further as interest rate differentials narrow, reflecting a potential dovish shift in U.S. Federal Reserve policy relative to other major central banks. Improved economic outlooks in China and Europe could also narrow regional economic growth differentials, further weighing on the dollar.
The year 2022 brought a notable shift in performance for global equities. In our view, improved outlooks in China and Europe, coupled with a weaker U.S. dollar, should be tailwinds for non-U.S. equity markets in the near term. As a result, T. Rowe Price’s Asset Allocation Committee is maintaining an overweight position in non-U.S. equities relative to U.S. equities.
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MSCI. MSCI and its affiliates and third party sources and providers (collectively, “MSCI”) makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed, or produced by MSCI. Historical MSCI data and analysis should not be taken as an indication or guarantee of any future performance analysis, forecast or prediction. None of the MSCI data is intended to constitute investment advice or a recommendation to make (or refrain from making) any kind of investment decision and may not be relied on as such.
This material is provided for informational purposes only and is not intended to be investment advice or a recommendation to take any particular investment action.
The views contained herein are those of the authors as of February 2023 and are subject to change without notice; these views may differ from those of other T. Rowe Price associates.
This information is not intended to reflect a current or past recommendation concerning investments, investment strategies, or account types, advice of any kind, or a solicitation of an offer to buy or sell any securities or investment services. The opinions and commentary provided do not take into account the investment objectives or financial situation of any particular investor or class of investor. Please consider your own circumstances before making an investment decision.
Information contained herein is based upon sources we consider to be reliable; we do not, however, guarantee its accuracy. Actual outcomes may differ materially from any estimates or forward-looking statements provided.
Past performance is not a reliable indicator of future performance. All investments are subject to market risk, including the possible loss of principal. International investments can be riskier than U.S. investments due to the adverse effects of currency exchange rates, differences in market structure and liquidity, as well as specific country, regional, and economic developments. These risks are generally greater for investments in emerging markets. All charts and tables are shown for illustrative purposes only.
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