Interest rates are rising in the U.S., but the yield of 3% of on 10-year Treasuries isn’t as enticing as it seems because it arrived there by way of falling bond prices and with more rate hikes to come, Treasuries just aren’t worth the trouble, low risk as they supposedly may be.
Then there’s U.S. stocks. Indeed, payouts here are growing and dividend stocks are outperforming the broader market, but with the S&P 500 down more than 13% year-to-date, a dividend yield of just 1.41% hardly qualifies as attractive.
Predictably, with U.S. stocks and bonds faltering, it’s not surprising that clients probably aren’t inquiring about international equities. Call it home country bias or just speculation that if U.S. stocks are falling, international equivalents must be doing worse, the reality is clients aren’t excited about ex-US stocks at the moment.
In many cases, they probably haven’t been for some time. Believe it or not, particularly for income-starved clients, now is an appropriate time to considering altering that playbook.
International Income Matters
The widely followed MSCI EAFE Index – a basket of ex-US developed market equities – yields an impressive 3.78%. However, the funds tracking that specific index and those like it usually aren’t high-dividend strategies in the strictest sense of the term.
However, that data point confirms many developed markets outside the U.S. offer superior dividend yields and at a time when global payouts are growing, some conversation about international stocks is merited. After all, it doesn’t mean client dollars have to flow that way right now.
“Investors, including those seeking income, tend to naturally favor that which is more familiar and better understood, resulting in a home country and familiarity bias,” notes Alerian’s Stacey Morris. “For US investors, performance trends have likely reinforced those biases, as domestic benchmarks have handily outperformed international developed markets over the last decade thanks in part to their significant exposure to the technology sector. With the volatility in equities this year and weakness in technology amid rising interest rates and supply chain issues – not to mention US consumer confidence plumbing decade-lows in May – it could be an opportune time for income investors to reconsider their international exposure.”
Another reason international equities and funds merit consideration today – and this speaks to why these assets are outperforming this year – is their value tilts. Many ex-US developed markets simply don’t have the glut of tech companies found in the U.S.
As such, the growth stock pullback afflicting domestic equities isn’t as severe in other developed markets and the latter category is poised to capitalize on a potentially lengthy value rally.
Aside from dividend growth, higher yields and the aforementioned value proposition, international dividend payers offer clients other perks.
“Developed market equities can provide both diversification benefits and yield enhancement to an income portfolio,” concludes Morris. “Beyond adding exposure to stocks that would otherwise not be included in a US-focused income portfolio, international equities may also be attractive due to lower correlations with other common income investments. For example, five-year correlations between international equities and REITs and utilities are around 0.6. International companies also tend to provide more generous income. The five-year average yield for the MSCI EAFE Index (MXEA) is 140 basis points higher than that of the S&P 500 (SPX).”
To be sure, international stocks aren’t a free lunch – there are risks to consider – but with income hard to come by and value available in the asset class, this is a client conversation worth having.