EAFE board
iStockphoto/Torsten-Asmus

Welcome to Soundbites, weekly insights on market trends and investment strategies, brought to you by Investment Executive and powered by Canada Life. For today’s Soundbites, we’re talking about the themes driving outperformance in Europe, Australasia and the Far East. Our guest is Isabella Giordano, vice-president, investment specialist with J.P. Morgan Asset Management. We talked about headwinds and names she likes, and we started by asking about the primary drivers behind recent EAFE outperformance.

Isabella Giordano (IG): Last year, we saw international equities outperform U.S. equities by about 14%. We finally saw the benefit of having a globally diversified portfolio live in action. And we’ve seen that outperformance continue into this year as well. For those considering whether or not to increase that allocation, the natural next question is, Have I missed the boat? For what it’s worth, we certainly do not think so, but no one has a crystal ball. There are three key considerations to explain why Europe, Australasia and the Far East — or EAFE — outperformed last year. I’ve packaged them into an acronym: CVS. The C is for currency. Last year, the U.S. dollar was down about 9%, meaning currency was a tailwind, not a headwind, to returns for international equities. And even with the dip we saw last year, the U.S. dollar still looks fairly overvalued versus its long-term history. We expect the dollar to continue to weaken gradually — on average, about a 1% annual devaluation over the next decade. The V is for valuation. Even after last year’s strong international returns, international equities are still trading at about a 32% discount to U.S. equities, where the long-term average discount is more like 19%. This discount actually persists across all sectors. And there’s still plenty of room to run. And that brings me to the S: sentiment. This is really what I view as the biggest catalyst to continue to help close that valuation gap. The positive sentiment shift for both Europe and Japan comes to mind. In Europe, you have a huge mindset shift from one of fiscal austerity, which has dominated over the last 15 years, to now fully embracing fiscal spending. And we’re in the early days of this shift. In our view, this is a true game changer for the European economy, which should be a tailwind to European earnings growth moving forward. But we haven’t just seen the fiscal stimulus in Europe. Recently, there was a new prime minister elected in Japan, really pivoting Japan towards fiscal stimulus as well. Historically, Japanese corporates have issued dividends. But now, because of the positive corporate governance reform measures instructed from the top down, we’ve seen a surge in share buyback activity from corporates as well, which, of course, helps to boost earnings-per-share growth of these companies. So, it’s not just one factor. It’s valuation setting the stage, sentiment driving flows, and currency adding incremental support, with earnings now starting to validate the move.

Cyclical rebound or structural shift

IG: I think there are both structural and cyclical components to the shift we’re seeing in global leadership away from the U.S. From a cyclical perspective, the U.S. has had an extraordinary run driven mainly by mega-cap tech and AI-related stocks. We’re now seeing a mean reversion phase where under-owned regions like Europe and like Japan are benefiting. And you’re also seeing global manufacturing and trade cycles stabilizing, which helps more export-heavy EAFE markets. The portion of the U.S. in something like the MSCI All Country World Index — or MSCI ACWI index —was 40% back in 2008 and today is just under 70%. So, a meaningful change. And this concentration has created valuation dispersion and diversification risk for many investors. We’ve been in a decade-long outflow from EAFE, and [are] now starting to see early signs of reversal. And while flows are not a guarantee of future returns, they often signal a reassessment of opportunity sets and portfolio construction priorities. So, the bottom line, it looks like a cyclical rebound with emerging structural support, but not yet a full handoff from U.S. leadership.

Names she likes

IG: The next phase of the AI trade is likely to be driven by adoption. As prior capex begins to translate into real deployment, we see the next beneficiaries as companies best positioned to integrate LLMs and agentic AI into workflows. A name like Sony, using AI to improve game development productivity. Hitachi, a Japanese electrification company who are embedding AI into their rail signalling business. Even a company like Next, the clothing brand, using AI to improve their inventory management. And even touching an industry like insurance, with a company like Munich Re, to better analyze their proprietary data. We’ve trimmed or exited software exposures where we think the range of outcomes is very wide and the business model could be a bit more vulnerable. Where we have kept exposure is in more walled garden data businesses, if you will. A name like RELX, the U.K.-based information analytics company. Even a company like London Stock Exchange, who own high-value market data that really matter for trading and back testing. We’re also thinking about how to best get exposure to the Europe spend beneficiaries and real assets that are harder to disrupt. Areas tied to electrification, grid resilience and physical world capacity — places we think you can find value without worrying as much about AI undermining the business model. A few examples of this would be Glencore, the Swiss commodity trading and mining company that has exposure to the real asset side of electrification, including copper. Another name we like is RWE, the German energy company that is levered to Europe’s need for more power generation and grid investment. And also Kubota, a leading Japanese manufacturer specializing in agricultural machinery, construction equipment and engines with durable end-demand. Again, a physical world business where disruption risk is lower.

And finally, what’s the bottom line on opportunities in Europe, Australasia and the Far East?

IG: There are three key messages I’d leave you with. The first is, diversification matters more than ever. We’re in a world of higher macro uncertainty, geopolitical tensions, market concentration risks. Relying too heavily on one market — particularly the U.S. — introduces undue risk in portfolios. The second thing is valuation dislocations creates pockets of opportunity for active managers to pick long-term winners where the share price has temporarily dislocated from the fundamentals. This is fertile ground for us to add value. And the third point is, stay invested through the cycle. Remaining invested for a long period usually produces better returns than trying to guess the best time to buy or sell. If you’re waiting for the ‘all-clear’ you often miss a meaningful portion of the rebound. Staying invested with the right mix keeps you participating when leadership changes.

Well, those are today’s Soundbites, brought to you by Investment Executive and sponsored by Canada Life. Our thanks again to Isabella Giordano of J.P. Morgan Asset Management. Visit us at investmentexecutive.com, where you can sign up for our a.m. newsletter and never miss another Soundbite. Thanks for listening.

**

Go back to the article.