Why De-Synchronization of World Markets is Good News For Investors

The 1970s through the late 1990s were a period of great change for the world's economies and financial markets marked by milestones such as a shift in the energy landscape, the rise of emerging markets, and several distinct boom and bust economic cycles. Through it all, a pattern of divergent economic growth trajectories of different countries around the world prevailed.

This de-synchronization meant that the world's stock markets often did not move in tandem, or even in the same direction. By diversifying internationally, investors could position themselves to take advantage of the distinct cyclical upswings and downturns of economies and markets, and reduce risk by spreading their bets among countries whose markets and economic cycles marched to different drummers.

Then, a sweeping change crept in. From the late 1990s until a few years ago global markets and economies became more synchronized than they had been in the past. Global diversification, while still a useful investment tool, lost some of its shine.

Experts cite a variety of reasons for the shift. In the late 1990s and again in 2008 and 2009, the tech bubble and financial crisis sent world markets down in tandem at dizzying speed. Investors may have perceived systemic risk globally, rather than country-specific. And trade policies were a coordinated effort that created a new inter-connection between world markets that benefited countries across borders.

Similar monetary policies around the world also played a key role. "The Federal Reserve, European Central Banks, and other central banks were on the same page when it came to monetary policy," says Josh Duitz, who manages the Aberdeen Total Dynamic Dividend Fund (AOD). "All of them were stimulating their economies though quantitative easing and lower interest rates."

Lower correlations create new diversification and investment opportunities

After a long hiatus lower market correlations and greater de-synchronization between countries and regions have made a comeback. The trend has picked up speed since 2016 and today, more divergent market correlations bear a close resemblance to those that prevailed when energy shortages and big hair dominated the scene. While markets around the world continue to move in a positive direction, they are taking more divergent paths to doing so than they have in nearly 20 years.

The reasons for this shift toward decoupling markets aren't entirely clear. Duitz thinks a contributing factor may be that central banks are no longer raising or lowering rates in unison. Instead, they're tailoring such changes to their unique economic cycles. In the United States, which is in a later economic growth stage than other countries, the Fed is well into the process of raising interest rates. In other areas where growth has been slower to take hold, such as Europe and Japan, monetary authorities are putting off any rate increases for at least a year or two. He adds that increased trade tension from tariff disputes, massive corporate tax cuts in the U.S., and a stronger dollar are all contributing to the increasingly divergent stock market performance.

Whatever the reasons lower correlations between world markets is, in many ways, good news for international investors. For those seeking to reduce risk exposures, it provides a tailwind for the traditional benefits of geographic diversification to kick in without sacrificing the potential to generate returns.

Reducing risk exposures through international diversification is always a good idea, but it is a particularly timely one now. Many think the "Goldilocks environment" for risk assets that prevailed over the last decade may shift into lower gear going forward. This year has already seen a spike in equity market volatility as investors price in the risk of higher inflation, the winding down of low interest rate environment, and withdrawal of fiscal stimuli. International diversification is a good way to navigate these undercurrents and avoid "betting the ranch" on a single market.

De-synchronization has also opened up better opportunities for international investors to shop the world for attractively priced stocks and take advantage of differences in country valuations. Stimulated by tax cuts and increasing corporate revenues, the U.S. market is experiencing its highest level of stock valuations since 2008. Recently, for example, the price/earnings ratio of the S&P 500 Index was 20.6, compared to 17.3 for the STOXX Europe 600 Index and 14.6 for the MSCI ACWI ex- U.S. The price/book ratio for the U.S. index was 3.4, compared to 1.9 for the European index and 1.6 for the global benchmark.

These less expensive markets offer a plethora of attractive buying opportunities for astute investors. Many stocks from emerging markets, Europe, and elsewhere are high quality, global leaders trading at a discount to comparable U.S. stocks, says Duitz. "These companies have similar business models, earnings profiles, and other attributes that are similar to those of comparable U.S. companies," he says. "They just aren't as expensive."

Leaving the U.S. comfort zone

For much of the past decade U.S. equities have outperformed their international peers, thanks largely to unprecedented accommodative monetary policy implemented during the financial crisis that paved the way for a head start towards economic recovery. U.S. companies have also cut costs and pared their debt during the recovery have been rewarded with improved earnings and more efficient operations. With all this good news on the home front, many U.S. investors continue to own portfolios that include few international holdings.

That could be a mistake. "Investors that have most or all of their money invested in the U.S. could be becoming too complacent," Duitz observes. "While the U.S. markets have outperformed others for most of the last few years, there is no guarantee that will be the case going forward."

The return of markets that move independently of each other amplifies the benefits of international diversification at a time when some signs point to the possibility of a shift in market leadership from the U.S. to elsewhere. U.S. equity market valuations are relatively expensive compared to other parts of the world, particularly for larger companies. The unwinding of accommodative monetary policies may come with its own risks, including the potential for higher market volatility and the possibility of a downturn in the equity markets. At some point, protectionist U.S. trade policies could short circuit earnings at some companies.

Beyond these short-term considerations, there are longer-term reasons to invest internationally. "While the U.S. is still a powerful force on the world economic scene, its dominance in terms of growth is clearly waning, " he says. "In 1960 the U.S. economy accounted for 40 percent of global GDP. Today, that number is less than 25 percent."

Venturing abroad also opens up new opportunities for income seekers. On average, dividend yields in Europe and other regions are at least twice as high as they are in the U.S. In Aberdeen funds, these high yields get a boost through dividend capture strategies, as well as a focus on stocks that are poised to declare special dividends as a result of unique, one-time events.

Why Aberdeen?

Headquartered in Aberdeen, Scotland, and with 46 offices in 24 countries, Aberdeen Standard Investments is uniquely positioned to capitalize on the world's most promising global opportunities, regardless of where they originate. With $735.5 billion under management, as of June 30, 2018, across diverse asset classes, the firm delivers original thinking, proprietary research, the highest level of service and support to thousands of institutional and retail clients.

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