For the past few years, many Wall Street strategists called the rotational shift from domestic equity returns (and flows) to international equity returns (and flows) incorrectly…or at least too early. Despite valid rationale supporting more growth potential in international stock markets than in domestic stock markets, given both the length of the secular bull market and economic recovery in the United States, the bull market run in the U.S. has continued. However, thus far in 2017 the tides appear to be starting to shift away from domestic shores and towards international countries.

As the chart below depicts, while U.S. stocks have outperformed both international developed and international emerging market stocks over the past five years, recent momentum appears to be on the side of international stocks based on 2017 year-to-date (YTD) return information.

Source: Bloomberg. All returns are USD total returns as of March 17, 2017. Total returns assume dividends are reinvested in the index. 3 and 5 year returns are annualized using weekly return data while 1 year and 2017 YTD returns are actual using daily return data. Past performance is not indicative of future results.

These YTD returns may come as a surprise to some investors as so much attention has been placed on the returns of U.S. stocks in conjunction with investor enthusiasm for certain areas of the market. These areas of the market are often associated with the “Trump Trade” and the Trump Trade momentum, while it has slowed of late, has taken the U.S. stock market to new, and record, highs during the 1st quarter of 2017. However, both international developed and international emerging markets, as represented by the MSCI EAFE and MSCI EMG indexes listed in the table above, have surpassed the U.S. stock market, as represented by the S&P 500 index listed in the table above, returns through March 17, 2017 and international emerging markets have returned more than the U.S. stock market for the past one year period as well.

Investors are starting to take notice of the international momentum story, at least as it relates to emerging markets. For example, the top gainer in exchange-traded fund (ETF) flows for the month of February 2017, according to ETF.com, out of the entire field of U.S.-listed ETFs, was the iShares Core MSCI Emerging Markets ETF (Ticker: IEMG), which pulled in $2.5 billion.

Drilling down further into country specific return shows an even more intriguing story as certain countries appear to be outpacing others within the two representative international market categories. Based on the chart below, with respect to the international developed market countries listed, Spain appears to be leading the way thus far in 2017 with a YTD gain of over 12%. Looking at international emerging market countries listed in the chart, Mexico has comes out of the gates strong with a 2017 total return gain of over 15% thus far.

Source: Bloomberg. All returns are USD total returns as of March 17, 2017. Total returns assume dividends are reinvested in the index. 3 and 5 year returns are annualized using weekly return data while 1 year and 2017 YTD returns are actual using daily return data. Past performance is not indicative of future results.

There are many different market events that could slow down this international equities momentum including, but not limited to, the following:

• Ramifications of key upcoming political votes which could lead to other potential country exits from the European Union
• The exact timing and logistics of the expected departure of Great Britain from the European Union (a.k.a. “Brexit”)
• Any potential changes to existing trade agreements or policies
• Policy changes coming out of Washington DC that could further boost U.S. economic growth and consumption
• Interest rate activity on the part of central banks across the globe and relative currency valuations – in addition to the Federal Reserve’s 25 Basis Point increase to the Fed Funds Target Rate in the U.S. last week, the Bank of England (BOE) is now expected to considering nudging their own interest rates higher following a recent report showing that inflation registered at its highest level in 3 years in Great Britain
• Commodity prices
• Any short-term bouts of stock market volatility
• Unexpected political or military shocks in any one region that could lead to global unrest

Recognizing all of these possibilities and associated risks, we, at Hennion & Walsh, believe that International equities, through International Developed Market, and some International Emerging Market, stock allocations, should be a part of most globally diversified portfolios in 2017 as a result of anticipated economic growth in many countries across the globe in addition to the anticipated stimulation measures on the part of central banks needed to spur additional economic growth.