Is the International Outlook Brighter Than the US?

Ivanna Hampton: Welcome to Investing Insights. I’m your host, Ivanna Hampton. We are recording this episode in front of a live audience here at the Morningstar Investment Conference at Chicago’s Navy Pier. This studio is super cool, if I don’t say so myself. Joining me today is Dominic Pappalardo, chief multi-asset strategist, and Philip Straehl, chief investment officer for the Americas for Morningstar Wealth. It’s part of a registered investment advisor, Morningstar Investment Management.

Hello, Dom and Philip. I’m so glad you’re here.

Philip Straehl: Great to be here.

Dominic Pappalardo: Thanks for having us.

How the Markets Have Been Handling Volatility in 2025

Hampton: Let’s get started. This week’s episode is focusing on whether the international outlook is brighter than the US outlook. But before we examine that, briefly share how you have viewed the first six months of 2025. Let’s start with you, Philip.

Straehl: Great. Absolutely. It’s been a very interesting first six months, I have to say. We’ve seen significant volatility in capital markets, and I might share some statistics around that just to kind of remind listeners, in terms of the period we’ve gone through and the volatility we’ve seen, people are sort of feeling warm and fuzzy again with the S&P 500 being close to record highs again. But we have seen some pretty significant volatility in recent weeks. We have seen two days in April where the S&P 500 lost almost 5% on April 3 and April 4. Then we had a day where it recovered, yielded about 9.5%. We have seen the S&P 500 in a bear market temporarily down 20%. The Mag 7 stocks between December and April lost about a third of their value. We’ve seen some pretty significant moves and unusual moves in the yield curve as well during the period of volatility in April. So it’s been an unusual period. We’ve seen a pretty sharp recovery in capital markets as well. But I would say the overarching theme was the volatility we’ve seen in the capital markets over this period.

Why Economic Data Has Stayed More Stable Than the Markets During Volatility

Hampton: And what about you, Dom?

Pappalardo: Yeah, Philip did a good job of summarizing what’s happened in markets. What’s interesting is from a macro perspective, economic data has been far more stable than the markets have been, and some of that could be a timing mismatch. So as most people know, tariffs really started to take effect in April. So maybe we haven’t fully seen the impact of those tariffs yet because economic data is obviously lagged. But things like GDP, CPI/inflation, and unemployment have all been relatively steady. The unemployment rate is still right around 4.2%, a reasonable number. Inflation keeps coming down. CPI was down to about 2.6%, depending which measure you use, which is still above the Fed’s target of 2% but is still trending lower. Even underlying that headline, energy, for example, is down 12% year over year through May. So we’ve seen some cost pressures alleviate, which obviously is not what people expected when the tariff headlines hit.

The one piece of macro information that’s really hard to figure out is the Fed situation. It’s still quite unclear what the Fed’s going to do, and when they’re going to do it. It seems apparent there’s been periods where the Fed would have liked to have lowered interest rates to maybe offset some of the market volatility we saw, but they’ve been hesitant to do so because inflation is still above their target range. So they’re in this conundrum where if they cut rates to support the economy and markets, it could spur inflation higher, but also they have to ensure inflation doesn’t go too high to start to really hamper the economy, the consumer, and kind of all the underlying fundamentals. So economic data has been strong. We’ll see what the coming months bring, and we’re watching the Fed very closely to see what they do next.

Why the Timing and the Scale of the Tariffs Were a Shock to the Market

Hampton: Now, a cloud of uncertainty over tariffs, high interest rates, and sticky inflation has hovered above everyday investors. Were the markets due for this type of volatility?

Pappalardo: It’s always unexpected when volatility hits. That’s why it’s volatile. So I don’t think bouts of volatility are unexpected. The reasons that cause it are often unexpected. I don’t think tariffs were a shock to the markets. I think the scale of the tariffs were a shock to the market. I also think the immediacy with which they were going to be implemented was a shock to the markets. Some of the tariffs were going to be implemented 48 hours after the initial announcement. That’s clearly not enough time for businesses or consumers to adjust their behavior, change their supply lines, or really cope with it in any meaningful way.

Will International Stocks Outperform US Stocks?

Hampton: Now, Philip, your team has forecast that international stocks will outperform US stocks over the next 10 years. Talk about why.

Straehl: Yeah, so taking a step back, if you look at where we’ve come from over this past decade, US stocks have done phenomenally well. They’ve returned about over 13% over the past 10 years. International stocks, less than 6% actually over that time frame. We do think that some of the forces that have pushed US stocks higher, we’re going to see somewhat of a reversal there, and we’re going to see a recovery in non-US stocks because some of these temporary factors that have impacted the underperformance will reverse on the other side. One example there is the valuation picture. We do think both developed- and emerging-market countries are more attractively valued, and we think that that will benefit performance over the next 10 years. The other dimension is what’s happening on the currency front. We have seen some US dollar weakness over the past few months, and we do think that that might continue over the next 10 years.

Why Now Is the Time to Check Your International vs US Stock Allocation

Hampton: Now let’s get into international equities. The Morningstar Global Market Index is made up of about 62% in US stocks and 38% in non-US stocks. What asset allocation do you think the typical US investor holds in equities, Dom?

Pappalardo: Yeah, I think exact percentages are difficult. I think the point that we would leave the audience with is now is a really good time to examine that non-US versus US split. And it’s very likely a lot of investors became overweight their US target just because of the performance that Philip alluded to, right? So multiple years in a row of outperformance, that allocation is going to increase relative to the non-US. We think now is a good time to reevaluate that and we think there’s meaningful opportunities outside the US. We like emerging markets, for example, particularly in Latin America. We’re still overweight China. So we think there are global opportunities that investors should consider.

And just to be clear, it’s not that we don’t like the US companies. We certainly think some of the strongest and most profitable companies are in the US. We just think the price you have to pay to gain exposure to them is too high right now. In other words, the expectations that are priced in are going to be difficult to achieve on an ongoing basis, particularly on top of the last five years’ performance that we just saw. So it’s just a good time to reevaluate that mix. And we think there’s more ponds to fish in outside of the US, so to speak.

Should Investors Broaden Their International Stock Exposure?

Hampton: And let’s bring you back into the conversation, Philip. Are we in a moment where a US investor should broaden their international exposure?

Straehl: Yeah, we think so. And we can see it both from a top-down perspective. I mentioned some of the kind of overarching themes from a top-down perspective, but also from the bottom-up perspective. Our equity analyst team, when they look at the underlying quality of the businesses and actually forecast the earnings power of these companies moving forward, we do think there’s opportunities there. Dom mentioned Latin America. We think global consumer stocks look particularly attractive, and we’ll spend some time on that later.

Why Global Consumer Stocks Are Poised to Perform Well During Market Volatility

Hampton: Well, let’s get into it because global consumer stocks like Burberry BBRYF, Kraft Heinz KHC, and BMW BMWKY, they’re exposed to inflation, the China recovery, and tariff uncertainty. Why are these undervalued stocks poised to do well in this challenging environment, Philip?

Straehl: Yes, so it really has to do with how mispricing in the market kind of manifests itself, and oftentimes investors overreact to short-term news. And there’s been several headlines, I would say, in recent years that have impacted the valuation of global consumer stocks. There’s been obviously, the inflation period that has impacted companies that are in the food manufacturing business—Kraft Heinz is one of the examples. Still, this year, our analysts expect a 3% impact on the bottom line of Kraft Heinz on the back of cost inflation that that company has to face. That’s one of the reasons why these companies have been trading at a discount to valuations.

We’ve also seen an impact of tariffs, of course. Tariffs have impacted companies that have complex supply chains around the world. Auto companies, BMW, one of the examples there. We do think a company like BMW, just because they have a diversified manufacturing base, they do a lot of manufacturing in the US, can withstand some of the potential pressures there. Then finally, another cause for potential cheapness is the slow postpandemic China recovery that we’ve seen, and a company like Burberry is exposed to the Chinese consumer. But taking a long-term perspective—which is really the core of our investing philosophy—we think that Burberry, as an example, stands to ultimately benefit from a recovery in the Chinese market and ultimately in terms of benefiting from a return perspective as well.

How Rising Yields in Fixed Income Can Create Opportunities for Investors

Hampton: Well, let’s shift to bonds. Yields on long-term government bonds have been rising in the US and in other countries. Dom, what is that signaling to you? And how could this affect everyday investors in the long term?

Pappalardo: Yeah, so no doubt over recent history, government-bond yields have moved up. They’ve kind of gone round-trip this year, just like equity markets have. Interestingly enough, Treasury bond yields rose in April when we saw stock market volatility, which isn’t the traditional relationship you would expect, but because there were inflation concerns, that pushed yields higher. In our view, fixed income as a whole offers an opportunity to investors, and now is a good time—much like we talked about with US/non-US splits—to reexamine your equity fixed-income splits, whether that’s US government bonds or international government bonds. Ten-year Treasury yields about 4.3%, 30-year Treasury yields about 4.8%. Those are right near long-term averages. So that allows fixed income to deliver that potential hedge to volatility in your portfolio because the income generation can offset some negative price action, which, if you go back to say 2022, where stocks went down and bonds went down, that wasn’t the case because Treasury yields coming into that period were so low, there was no income cushion to offset the negative price action investors experience.

How the Shape of the Yield Curves Have Shifted

Hampton: And Dom, on the Jan. 3 episode of Investing Insights, we talked about the fixed-income opportunities that really existed outside the US. What’s the midyear update?

Pappalardo: Yeah, I think when we had that conversation, one of the things we liked was emerging-market debt, obviously higher-yielding than the US because it’s lower quality and higher volatility. That different differential between those two has actually compressed. So if you had owned emerging-market debt, you would have outperformed US Treasury debt. Today, that compensation spread is not as appealing as it was six months ago. So perhaps not as appealing, but we still think it’s close to offering some value to investors.

What’s really happened more than yields moving up has been the shape of the yield curves have changed globally. So going back to the beginning of this year and certainly in 2024, many global yield curves were inverted, meaning that short-end yields were higher than longer-end yields, which is an abnormal situation to be in. That has really normalized across the globe to be more like historical long-term averages where short-term yields are less than long-term yields. So it’s really been a function of changes in the shape of the yield curve, and we’ve done a lot of work to try and examine the best way to take advantage of that. And our team really thinks that being concentrated in the middle of the maturity range—kind of that five- to 10-year maturity range—is kind of the optimal exposure right now.

How US Investors Can Mediate US Dollar Weakness With International Equity Exposure

Hampton: Good to note. Another big story this year has been the US dollar. It’s been weaker. How should investors think about currencies? And another question, is this something ordinary investors should factor into their investments? Philip?

Straehl: Yes, great question. We’ve seen some US dollar weakness this year. Our view for some time has been that the US dollar was expensive relative to other currencies. We use a pretty long-term approach to sort of assessing the relative valuation of currencies. Our view was that the US dollar looked expensive. The question was, what was a potential catalyst for that valuation gap to start closing? And I think in recent months, we have started seeing some catalysts that have pushed particularly foreign investors to reconsider how much non-US or nondomestic currency exposure they should have in a portfolio.

If you’re sitting in Europe and you’re owning an equity index, global equity index, chances are your US dollar exposure has unintentionally sort of increased over the past five to 10 years. We looked at the stat earlier in terms of the composition of kind of a global equity portfolio. A lot of foreign investors were exposed and perhaps overexposed to the US dollar. As a result of the recent weakness, not only in the equity side but also on the currency side, more foreign investors have been reexamining how much exposure they should have to the US dollar. We think that’s a potential catalyst. We have also seen the asset class, some US dollar assets, equities in particular, underperform, and we think that that has room to continue.

In terms of the question of how individual investors might get exposure to that—and I think one way to think about that, probably the easiest way to think about that—is to look at increasing your non-US exposure in terms of equity. So you have international equity exposure. When you do that, you automatically get more exposure to euro, the yen, other emerging-market currencies. That’d be one way of doing that.

Key Takeaways on the US Market Outlook vs International Market Outlook

Hampton: Well, the time has gone by so fast. So one last question. What is the main takeaway on the international outlook versus the US outlook? Philip, let’s go with you.

Straehl: Yeah, so I would say, look, in terms of what we think a good investment process looks like is to have kind of a forward-looking understanding of what valuations look like. One of the mistakes many investors make is to assume that the future mirrors the past. We think today is one of those moments in time where when we look at our bottom-up valuation-driven process where international markets look more attractive we think in both developed and emerging markets—there’s more opportunities today.

Pappalardo: I’ll take a slightly different angle on that question, if that’s OK. I just want to be clear that we’re not suggesting investors should avoid the United States. There’s obviously a lot of great companies and great opportunities in the US market. We just think that the market as a whole is overvalued. We think the opportunities in the US, you should be selective in where you gain your exposure. So for example, we still like small-cap stocks in the US. They’re trading quite cheap compared to large-cap stocks right now. We like the healthcare sector. Strong fundamentals, has some pretty negative sentiment around it for a variety of reasons, but the fundamentals are holding up and prices have fallen. We think that’s an appealing opportunity. Philip alluded to some of the consumer stocks that obviously cross over into the US. So just to be clear, we’re not suggesting that people liquidate their United States equity holdings. We just think you should be selective in the exposures you do add or do maintain. If you’re looking for new opportunities, the non-US arena might be more appealing right now.

Hampton: Well, thank you both for this great conversation and those great takeaways and for joining me at this special table at the Morningstar Investment Conference.

Pappalardo: Thanks for having us. A lot of fun.

Straehl: Great to be here. Thanks, Ivanna.

Hampton: Awesome. So everyone listening and watching, thank you for tuning into this special episode. I’m also sending my gratitude to an amazing team that made this happen. Senior Video Producer Jake Vankersen, Lead Technical Producer Scott Halver, Senior Audio Engineer and Producer George Castady, and Associate Multimedia Editor Jessica Bebel. I’m Ivanna Hampton, lead multimedia editor at Morningstar. Take care.