About this episode
With questions around equity outperformance, tech overvaluation and currency headwinds in the U.S., retail investors may want to look internationally to diversify their portfolio. Chief Cross-Asset Strategist Andrew Sheets and Chief Investment Officer for Wealth Management Lisa Shalett discuss. Lisa Shalett is Morgan Stanley Wealth Management’s Chief Investment Officer. She is not a member of Morgan Stanley Research. ----- Transcript ----- Andrew Sheets Welcome to Thoughts on the Market. I'm Andrew Sheets, Chief Cross-Asset Strategist for Morgan Stanley Research. Lisa Shalett And I'm Lisa Shalett, Chief Investment Officer for Morgan Stanley Wealth Management. Andrew Sheets And today on the podcast, we'll be discussing the role of international stocks in a well-diversified portfolio. It's Thursday, April 28th at 4:00 p.m. in London. Lisa Shalett And it's 11:00 a.m. in New York. Andrew Sheets Lisa, it's so good to talk to you again. There's just an enormous amount going on in this market. But one place I wanted to start was discussing the performance of U.S. assets versus international assets, especially on the equity side. Because you've noticed some interesting trends among our wealth management clients regarding their U.S. versus international exposure. Lisa Shalett One of the things that we have been attempting to advise clients is to begin to move towards more global diversification. Given the really unprecedented outperformance of U.S. equity assets, really over the last 12 to 13 years, and the relative valuation gaps and most recently, taking into consideration the relative shifts in central bank policies. With obviously, the U.S. central bank, moving towards a very aggressive inflation fighting pivot that, would have them moving, rates as much as, 200-225 basis points over the next 12 months. Whereas other central banks, may have taken their foot off the accelerator, acknowledging both, the complexities of geopolitics as well as, some of the lingering concerns around COVID. And so, having those conversations with clients has proven extraordinarily challenging. Obviously, what's worked for a very long time tends to convince people that it is secular and not a cyclical trend. And you know, we've had to push back against that argument. But U.S. investors also are looking at the crosscurrents in the current environment and are very reticent and quite frankly, nervous about moving into any positions outside the U.S., even if there are valuation advantages and even if there's the potential that in 2023 some of those economies might be accelerating out of their current positions while the U.S. is decelerating. Andrew Sheets It's hard to talk about the U.S. versus the rest of world debate without talking about U.S. mega-cap tech. This is a sector that's really unique to the United States and as you've talked a lot about, is seen as kind of a defensive all-weather solution. How do you think that that tech debate factors into this overall global allocation question? Lisa Shalett I think it's absolutely central. We have, come to equate mega-cap secular growth tech stocks with U.S. equities. And look, there's factual basis for that. Many of those names have come to dominate in terms of the share of market cap the indices. But as we've tried to articulate, this is not any average cycle. Many of the mega-cap tech companies have already benefited from extraordinary optimism baked into current valuations, have potentially experienced some pull forward in demand just from the compositional dynamics of COVID, where manufactured goods and certain work from home trends tended to dominate the consumption mix versus, historical services. And so it may be that some of these companies are over earning. And the third issue is that, investors seem to have assumed that these companies may be immune to some of the cost and inflation driven dynamics that are plaguing more cyclical sectors when it comes to margins. And we're less convinced that, pricing power for these companies is, perpetual. Our view is that these companies too still need to distribute product, still need to pay energy costs, still need to pay employees and are going to face headwinds to margins. Andrew Sheets So what's the case for investing overseas now and how do you explain that to clients? Lisa Shalett ] I think it's really about diversification and illustrating that unlike in prior periods where we had synchronous global policy and synchronicity around the trajectory for corporate profit growth, that today we're in a really unique place. Where the events around COVID, the events around central bank policies, the events around sensitivity to commodity-based inflation are all so different and valuations are different. And so, taking each of these regions case by case and looking at what is the potential going forward, what's discounted in that market? One of the pieces of logic that we bring to our clients in having this debate really focuses on, the divergence we’ve seen with currencies. The U.S. Dollar has kind of reached multiyear extreme valuations versus, the yen, and the euro and the pound. And currencies tend to be self-correcting through the trade channels, and translation channels. And we don’t know that American investors are thinking that all through. Andrew Sheets Well, I'm so glad you brought up the currency angle because that is a really fascinating part of the U.S. versus rest of world story for equities. If we take a market like Japan in yen, the Nikkei equity index is down about 4% for this year, which is better than the S&P 500. But in dollars, as you mentioned the yen has weakened a lot relative to the dollar, the Nikkei is down almost 14% because the yen has lost about 10% of its value year to date. So, when you're a investor investing in a market in a different currency, how do you think about that from a risk management standpoint? How do you think about some of these questions around taking the currency exposure versus hedging the currency exposure? Lisa Shalett Well, for the vast majority of our clients who may be, owning their exposures through a managed solution, through a mutual fund, through an ETF, currency hedging is fraught. And so very often, we try to encourage people to just, play the megatrend. Don't overthink this. Don't try to think that you're going to be able to hedge your currency exposures. Just really ask yourself, do you think over the next year or two the dollar's going to be higher or lower? We think odds are pretty good that the dollar is going to be lower and other currencies are going to be stronger, which creates a tailwind for U.S. investors investing in those markets. Andrew Sheets I guess taking a step back and thinking about the large amount of assets that we see within Morgan Stanley Wealth Management. What are you think, kind of, the most notable flows and trends that people should be aware of? Lisa Shalett As we noted, one of the most, structurally inert parts of people's portfolio is in their devotion to US mega-cap tech stocks. I think, disrupting that point of view and convincing folks that while these may be great companies, they perhaps are no longer great stocks is one that that has really been an effort in futility that seems only to get cracked when an individual company faces an idiosyncratic problem. And it's only then when the stock actually goes down that we see investors willing to embrace a new thesis that says, OK, great company. No longer great stock. Andrew Sheets Tomorrow I’ll be continuing my conversation with Lisa Shalett on retail investing, ESG, and what’s been happening in fixed income. Andrew Sheets And as a reminder, if you enjoy Thoughts on the Market, please take a moment to rate and review us on the Apple Podcasts app. It helps more people find the show.