Summary
- Foreign stocks trade at just 12 times expected earnings - much cheaper compared to US large caps.
- I expect outperformance from non-US names, but investors should monitor moves in the dollar.
- I outline key price levels to watch as the market appears to be in correction mode.
Investors must keep their eyes on the US dollar. The chart below illustrates that the greenback has climbed back to its highest level since nearly early December last year. The driver here is an uptick in domestic inflation figures. That might sound like the currency should dip, but in this case, it means higher interest rates caused by a hawkish Fed.
With a terminal rate now near 5.4% and (finally) no cuts priced into the market this year, interest rate differentials between the US and other major economies (namely the Euro Area) mean that the dollar is fundamentally at a higher value today. That often pressures non-US equities, but are we seeing that now? Let's take a look at one major index fund tracking the foreign stock market.
On Dollar Watch
According to Vanguard , the Vanguard Total International Stock ETF (VXUS) seeks to track the performance of the FTSE Global All Cap ex US Index, which measures the investment return of stocks issued by companies located outside the United States. The fund has an exceptionally low 0.07% annual expense ratio and is a large-blend ETF when plotted on the Morningstar Style Box.
Launched in 2011, VXUS offers diversified exposure to a cap-weighted foreign equity index and uses a passively managed, index replication method. It holds more than 3,300 stocks. Tradeability is high, with a 30-day median bid/ask spread of just 2 basis points and an average daily volume of about 3 million shares.
Compared to the US stock market, VXUS has a low price-to-earnings ratio. Vanguard lists the earnings multiple at 12.0 while the price-to-book ratio is 1.6. But the chart below shows the valuation difference better. Right now, the US/foreign forward P/E gap is near the highest we have ever seen.
For that reason (being cheap on both an absolute and relative basis), I like VXUS as an overweight. Considering that the international market accounts for about 38% of the world, going up to 45% or 50% makes sense to me. That's how I am positioned in my portfolio.
US and Foreign Stock Valuations
Digging deeper into the portfolio, the median market cap is large at $32 billion, and earnings growth has been in the 6% to 10% range. In terms of the factor profile, it is definitely more value-oriented compared to the S&P 500, but it's still middle of the road when it comes to the overall value-growth spectrum and yields more than the US market by more than double (3.8% yield on VXUS).
VXUS Portfolio & Factor Profile
Let's look at a pair of charts to see where the risks and reward potentials are. Following hot US inflation data this past week, all equities have faltered. VXUS has simply meandered versus the Vanguard Total US Stock Market ETF (VTI) in the last few weeks after a strong run-up from October last year through January. I see the pause as a mere correction in the trend, and that VXUS should resume outperformance later this year. Of course, how the dollar performs is key.
VXUS Pairing Some Relative Gains
Looking specifically at the chart of VXUS, I see some near-term bearish risks following a break of support in the $54 to $55 range. Downside levels to monitor are the flat 200-day moving average at $52 and the late 2022 low near $51. Bigger support in the $48.50 to $49.50 range should cushion against a more significant downside, as the October low looks firm to me. The bulls want to see shares rise above $57 to confirm a continuation of the uptrend.
VXUS: Some Further Downside Expected, Buy The Dip
The Bottom Line
I like VXUS on long-term valuation and relative to domestic equities, but there are near-term technical risks. Hence, I am a hold on the ETF for now, but VXUS is an ideal, low-cost, and highly liquid way to gain exposure to foreign markets.
For further details see:
VXUS: Foreign Stocks Cheap, But Technical Risks Near Term