The Kale of Investing Is Tasting Better

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I totally am sympathetic to the view that international stocks have not worked in 15 years, something like that. So why is now the moment? Valuations are never the reason that a particular sector of the market is going to work. You need catalysts. And I think we've got 5 catalysts.

5 catalysts. I'd have been satisfied with 1 or 2. Welcome to the Barron's Streetwise Podcast. I'm Jack Howe, and the voice you just heard is Nanette Abelhoff-Jacobsen. She's the global investment strategist for Hartford Funds, and she's talking about International stocks. Do not make that face. They're good for you. You might even like them. They're outperforming the US this year by a lot. We'll talk about it. Listening in is our audio producer Alexis Moore. Hi Alexis.

Hi Jack.

I'm hitting the little button on my iPhone to turn the ringer off and I'm reminded we had that conversation with a certain, tech executive and co-founder and newly minted billionaire that we will be hearing from in an upcoming episode of this podcast. People will have to guess which one. And he gave me that tip. He said that he has re— this is called the Action Button. It's the little button on the iPhone, right? And he said that he and a lot of his friends and peers have remapped that button to ChatGPT. So you can just, I guess, hit the button and have AI answer your questions. He says that's how he searches for things now. And my plan is I'm going to spend some time figuring out how to do that, and then I'm going to lord that tip over all of my Neanderthal friends who probably still have their little button set to mute and unmute. What do you think?

That would be an incredible flex.

Although an even hotter trend I'm hearing about is people are mapping that button to just play the Baron Streetwise podcast. Absolutely no one. I think, I think you could have your iPhone taken away for that. That episode and conversation is coming. Today we want to talk about international stocks. We touched on this topic, I think it was in March. That episode was called something about, is your S&P 500 fund enough? Something like that. It's been doing so well for so long and other markets had started to outperform. And that has continued so far this year. If you own like a cheap index, a world ex-US stock fund, you've outperformed the S&P 500 by 13 percentage points year to date. A couple of the points I made in that earlier episode, there is solid evidence to suggest that investors, that US investors should diversify in overseas markets, but it is a total drag. And the reason is because over any meaningful time period for today's investors, US stocks have outperformed. Here's where all the big, glamorous, successful tech and dot-com and AI companies are. There was a big story in the Wall Street Journal just in the middle of May on this subject. It was titled, The Tech Industry Is Huge and Europe's Share of It Is Very Small. It says a risk-averse business culture and complex regulations have stifled innovation on the continent, weighing on its future. Europe's Google is Google. Its Meta is Meta. Its Apple is Apple. International diversification wasn't always a thing for stock investors. Back in March, I mentioned a landmark study from the 1970s that talked about how investors could reduce overall portfolio volatility by holding some portion of their stock money overseas. Before then, most investors used to diversify their stock money by just holding lots of different stocks in the U.S. After that research, the mutual fund industry began to slowly respond to investor demand for overseas stocks. But the real-world returns have mostly not followed the research. I talked to March about 125 years' worth of stock market data that generally showed US outperformance. Europe has disappointed in recent decades, Japan too, even emerging markets. China has been a 3-decade economic miracle and stock market disappointment. But the outperformance of US markets means that they have gotten more expensive than overseas markets. For bargain hunters, the valuation gap has become tempting. US investors also get more than exposure to other markets when they diversify overseas. They get exposure to other currencies. That's helpful if you're worried that a recent dollar decline will continue. Now with international markets doing so well, there's this intriguing prospect that the thing that is good for you might also taste good. Imagine that. Alexis, I was going to use lima beans as an example here, but maybe those are too starchy. I'm thinking kale. You like kale?

I do like kale. Yeah. Sautéed some onion and garlic.

Sautéed. Does that soften it up a bit? Yeah, because I had a kale salad, right? Kale is supposed to be a superfood and a lot of fiber and all this great stuff. I had a kale salad. This was at the office. I was eating it with a plastic fork. A tine of the fork— that's one of the prongs of the fork— broke off into the kale salad. And I took a forkful of salad. I couldn't tell the difference between the plastic fork tine and the kale for kind of a long time. I was lucky that I didn't swallow it. Kale could have killed me. That's all I'm saying. Wow. I'm not doubting the nutritional benefits of kale. I'm just saying kale is a silent killer. Let's be careful out there. Where was I before this public service announcement? Ah, yes. International investing. Good for you. And maybe tastes good. Outperforming. There's also obviously one other big thing that has changed since our earlier discussion in March, and that is Tariff Liberation Day, which was in early April. The announcement of big sweeping worldwide tariffs and a fairly violent stock market reaction to the downside and a bond market reaction too. And then the announcement of a pause in those tariffs for 90 days while the US negotiates with its trading partners. Markets have bounced right back, but there could be some lingering or broader effects here. If globalization was one of the things that over decades held price growth low here in the US, and if low inflation was one of the things that helped the Federal Reserve bring down interest rates, And if falling interest rates was really the fuel for bull markets in stocks and bonds and collectibles and just about everything, and finally, if we're now entering a period where globalization is stalling or going into reverse, it makes you wonder how markets are going to do without those other tailwinds. It's not a disaster for investors, but it makes me think about the possibility of more volatility down the road. And what can investors do to offset that volatility? Well, diversifying is one of those things. It's certainly no reason to flee the US stock market and go all in overseas. But if your overseas allocation is minuscule or nonexistent, maybe it's a good moment to rethink that. So that's why I wanted to speak with Nanette. And my first question for her was, is this another head fake? A head fake is a sort of bobbing of the head up and down to mislead a defender in basketball into thinking that you're And I'm good at head faking, not because I'm athletic, but because I have a pretty large head. It's just a lot of misdirection. All right, with that, let's get to Nanette.

I totally am sympathetic to the view that international stocks have not worked in, you know, 15 years, something like that. So why is now the moment? And I think that valuations are never the reason. That a particular sector of the market is going to work. You need catalysts. And I think we've got 5 catalysts. One is the fundamental picture, uh, in the U.S. due to tariffs. So I see growth weakening somewhat and inflation pressures building. Number 2, there's a lot of uncertainty in the U.S. about policy, and that means that you need to get compensated more for U.S. equities relative to international equities. Third, fiscal stimulus. We've met a watershed moment in Europe where they're really showering €1 trillion of stimulus to face the problems that they've faced for so many years. U.S. dollar strength is challenged. We've seen that Moody's downgraded the U.S. and tech sector. The mega-cap tech stocks, it's at least these are great companies, but it's more of a mixed picture. Those are the 5 reasons.

Hmm. There's a bunch of those that I want to dip into. I guess maybe we'll start at the end, the tech sector. I was just reading something in our, in the Wall Street Journal, our sister publication, about, um, it was basically Europe doesn't, you know, Europe is so many steps behind on artificial intelligence and these big tech companies, and why doesn't Europe have more of a big tech sector like the US? So is it that you think maybe Europe's day is coming, that it can develop more of a tech sector, or is it that you think that the high weighting we have in the US stock market in the tech sector might be trouble?

Yeah, I think it's a little bit of both, Jack. I think the first thing is that in the US tech sector, there are questions about all the CapEx investments. So in total, we're talking about $1 trillion of CapEx investments. And, you know, what's the return on invested capital on that? The tech companies are facing more competition. Deepseek sort of catalyzed that moment, but it's been happening. And another aspect is that tech companies may be a bit more cyclical than we realized because a lot of the revenues these companies earn are from advertising. And so if there is a weaker economy, that source of revenue could suffer somewhat. And then, you know, on the other side in Europe, you're getting this shakeup because of the tariffs on the US and the threat of tariffs that they've got to really get their house in order. And the biggest headwind has been regulation. And so we're hearing now that the regulatory environment is improving. And things like that could mark a moment, at least where relatively speaking, you see a positive change toward Europe and away from the US.

Interesting. You mentioned fiscal stimulus. Tell us more for the benefit of people who might not realize what's going on. Fiscal stimulus, uh, it sounds like a very un-German thing, and yet I hear the Germans And the Germans are doing it. Tell us about what that means, you know, for investors.

Yeah, you know, what I always equated Germany with was austerity, and that was in full display during the eurozone crisis. Instead of showering stimulus the way the US did during COVID they pulled back and they've been limiting government spending. You know, this German government has been very stingy when it comes to government spending. So the first thing they're doing is, in Germany specifically, they're lifting the cap on spending on defense.

Germans who are hearing this right now are saying prudent, not stingy, prudent. But go ahead.

Go ahead. You know, I mean, when you're not prudent like the U.S., there are other things to reckon with. So, you know, there are obviously limits to all these things. But it's always been the case that Germany consumption has been held back and spending by the government too. Defense spending is definitely going to increase. The EU is going to also have shared investment. And then there's going to be more investment for infrastructure, which has always been a weak link in Germany. And that would include technology.

How about the tariffs? Who gets hurt most from the tariffs? I mean, they affect Europe just like the US. So why would tariffs be a reason that investors ought to shift their preference toward Europe?

So really, this comes down to the fact that the source of tariffs are coming from the US. They are spread all over the world. And then the question is, what are the retaliatory tariffs? And the point that I'm making is that retaliation comes from all sides and it's directed to the US. So on balance, even though the US tariffs do bring in some revenue and they're targeted at other countries, there's retaliation that we need to account for, and that retaliation is going through a funnel toward the US.

Thank you, Nanette. Let's take a quick break and we'll be right back with our conversation.

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Welcome back. We're talking about international stock investing. Let's get back to our conversation with Nanette from Hartford. Hartford Funds, not Hartford, Connecticut. Hardford Funds are based in Pennsylvania. The history goes back to a fire insurance company in Hartford, Connecticut. I know this because I went down a whole internet rabbit hole on it.

Don't ask.

Here's the net. How about the valuations this year? Overseas markets have outperformed. What about the investor who says, I'm too late? You know, I should have listened to you before, but I missed the boat because Overseas markets have had their run now.

Yeah. And that's why I wrote the piece, because I thought investors would say, I'm too late. Why should I get in now? I think that in Europe, certainly valuations have gone up. They're still cheaper than the US. And so I still think there's runway. We were just talking about the telecom sector, and that's a really good place to look at as regulation is becoming looser. There. So there are many sectors outside of the defense sector that you can still look at and find value. And even in the more value-oriented parts of the market, that's where we would be looking, even in smaller cap, like in the mid-cap sector. That's Europe. Japan is still cheap. We often think about international as just Europe, but the market is really overlooking Japan. And Japan has not participated in the outperformance that we've seen relative to U.S. Equities. And I think there's a lot more runway for Japan to outperform.

Let me ask you to just give me a little more on the subject that you were just talking about, which is which parts of these markets are particularly attractive right now, and be as granular as you can. You may or may not be able to talk about specific companies, but if not, which industries and things like that do you think are attractive?

Yeah, sure. So in Europe, we would be focusing on financial companies, energy companies. So that is the more value-oriented sector. We'd also be going lower cap into mid-cap because some of the large-cap companies have priced in a lot of the good news. So that's in Europe. And then in Japan, we're looking at domestic industries. So these are ones that are not going to be hurt. By a stronger yen. And so that's what you always have to think about, is how international are these businesses. So we would stick to domestic industries in Japan and also financials, which would be a levered way, if you will, of taking advantage of higher valuations in and better growth and nominal growth prospects in Japan.

What do you think is next for the U.S. Dollar. If you can't tell me to 2 decimal places what's going to happen next week, at least give me a general— at least give me your best, you know, guess at what might happen in the years ahead.

Yeah, I think, you know, the dollar is facing headwinds. There is question about primacy of the currency as a reserve currency. And I know you're going to ask me, but what are the alternatives? So I'll address that. Up front, you know, the central banks all over the world have been reducing their reserves in the dollar. They've been replacing it with other currencies. They've been huge buyers of gold. And I think these are all moves toward mitigating the risk in the dollar. So it has been, you know, on an effective exchange rate expensive for a long time. And now you've got reasons specifically on the fiscal side that we're looking at $29 trillion of public outstanding debt, a deficit of, you know, going to 8%. And you have debt-to-GDP that is on track to go to 120%. And that was really the catalyst for Moody's to downgrade US debt.

You work for a firm that takes an active approach to managing investor money. And so if we were talking about a US large-cap fund, I feel like I could make a very strong case that cheap index fund has done a good job of it the past, you know, couple of decades. And so maybe we might think there's reason things are going to change, but if not, that index fund seems to have served people well. So my question is, in the area that you focus on, on international stocks, how well served are people by indexes? And what's the case for using active management in those parts of the investing world?

The first part of my answer is that if you're investing in international, you gotta be really careful about what index or what benchmark or what passive strategy you're using. There's a whole potpourri of indexes that include the US. So if you are looking at a world index, many world indexes have 70% of US companies in it. So you're really not getting very much international exposure at all. You have to look at EFA strategies or world ex-US. So there's just an implementation piece of this that's important. You know, the other thing about active is just that the areas of the market that are less efficient are going to be areas where active is more interesting and generates more return. So in active, in European markets, you're going to want to look at specific sectors, you know, in the healthcare market, in the telecom market, in energy companies. And right now, you know, most of the index is in a couple of German companies and pharmaceutical companies. There is some real tech concentration in European markets. So where tech goes, goes the European market. So that's why I just think that you'd want more active exposure so you're not sitting with those big passive weights.

How much should I be allocating? I hate to talk like such an American, like there's the US, there's just everything else. That's all, just two buckets. And I know that this is a question for a financial advisor, but just suppose that I'm ordinary in every conceivable way, an ordinary person of ordinary means, an ordinary age, and so forth. Should I go by the market cap weighting of the stock universe? As you just said, that US weighting is pushing 70% of the world right now. Should I start there and have, you know, low 30% allocation to everything but the US? Or should I have more? What do you think?

Yeah, I mean, I think it's a good starting point, but then I think that this rotation out of the U.S. into the rest of the world, developed markets in particular, does deserve a slight overweight. So, you know, um, if that's 5% or 10%, but that's the range that I'm thinking about. And you would gauge that by where valuations are. And of course, you know, move into that overweight in a gradual way.

Just hard for me to get. I know it makes sense. I know, by the way, even before overseas markets started performing as well as they have this year, I looked at it like an eat your vegetables kind of thing. I, you know, it's, it's good for me. I'm not sure when the payoff will be, but I can see on paper, it makes a lot of sense that I'm supposed to do it. It's hard to think through what is it going to look like? Like, let's say that, that this comes to pass and over, let's say over the next 10 years, We look back and we find, okay, overseas markets did outperform the US. And so I'm glad that I had this weighting in them. I just wonder what form that outperformance will look like. Is it just going to be that the valuations there catch up? Is it going to be that there is some kind of transformation of the economy? I don't know. What do you think? If this comes to pass, what do you think we'll say about the European economy 10 years from now when we look back? Japan, for that matter.

Yeah, I mean, I do think that this slap in the face of Europe, you know, by threatening these huge tariffs is forcing them to take a hard look at their technology, at their regulation. And I think the regulation, when you talk to people about doing business in Europe, that's when you get the groans. And so they know that they've got to make it easier. To do business. They've got to create efficiencies in terms of both generating returns, returning capital to shareholders, and to cutting costs. And I think that we're kind of at an existential moment where they take this chance to do that. The thing is, they have the scope in terms of government spending. They can spend the money. They've got more scope than the US has. So that's why I think that this is a longer-term project. And 5 years from now, even, I don't think we need to wait 10 years. We're going to say, yeah, this was a turning point. And we saw some of that gap between the US and the rest of developed markets close.

You've got my interest for sure. I really wonder whether this is going to happen. I can't figure it out.

It's intriguing. Hopefully we'll talk again sooner than 5 years, but you can mark the date.

Thank you, Nanette, and thank all of you for listening. If you have a question you'd like played and answered on the podcast, just send it in. It could be in a future episode. Use the voice memo app on your phone and send it to jack.hough@barons.com. Alexis Moore is our producer. You can subscribe to the podcast on Apple Podcasts, Spotify, wherever you listen. And if you listen on Apple, you can write us a review. No big Whoop. Who am I kidding? It's a huge whoop. See you next week.

Data is everywhere. When orchestrated properly, it sings. At Morningstar, we analyze and enrich data, making it actionable and powerful for you. Morningstar, where data speaks.