Global Perspectives: Are we seeing a regime shift between U.S. and non-U.S. stocks?

Lara Castleton: Hello, and thank you for joining this episode of Global Perspectives, a Janus Henderson podcast created to share insights from our investment professionals and the implications they have for investors. I’m your host for the day, Lara Castleton, and today we’re getting an update on the global opportunity set for equities.

As of the date of this recording on May 30, ex U.S. markets have handily outperformed the U.S., with some countries outperforming more than 30%. We’ll discuss a few reasons why this happened, but the biggest question we all have is whether or not this is yet another head fake for global equity resurgence, or if this truly is the start of a regime shift.

To share their insights and expertise, I’m back with Julian McManus and Chris O’Malley, Portfolio Managers on our Global Alpha Equity team. Gentlemen, thank you for being here.

Julian McManus: Yeah, thank you for having us.

Castleton: Julian, I want to get started with you. I know you can’t foresee exactly what’s going to happen over the coming months, but it does seem like there’s been a pretty big shift since “Liberation Day.” Is this finally the catalyst for a shift in global sentiment to ex US equities?

McManus: It quite possibly is. If we take a step back and look at the setup before tariffs changed everything, the setup was that we had all-time wides in terms of valuation discounts of international versus the U.S. So, the U.S. was trading at around 20 times earnings and a lot of international was trading around 12 times earnings.

So, that disparity alone made for an overextended start. And then we’d been looking for what was going to be the catalyst to break the cycle. And when I say cycle, there was another cycle that had been driving this disparity for a long time, which was the interrelationship of passive investing and large-cap tech outperformance. And the two were co-dependent in the sense that the more that large-cap growth and tech outperformed, the more it sucked in more passive money, and it fueled that outperformance of large-cap growth and tech. And so, it was difficult to foresee what was going to be the catalyst or the trigger that was going to break that cycle.

But this looks like the most likely or powerful thing to break that cycle. Whether it sustains is really, you know, the big question and very difficult to call. Some U.S. growth names actually have, you know, did actually start to look pretty attractive again on valuation; not all of them. It’s very difficult to make a prediction here, but I think this is the best chance that we’ve seen in a long time of things reversing, and there’s still a lot of capital that can flow back the other direction.

Castleton: Okay, and Chris, I’ll go to you now. Thank you for outlining that overlay on the shift in sentiment. But there are some dynamics that were happening pre-Liberation Day, which was kind of the big shift, it seemed like, at least headline-wise. So, walk us through, again, what was happening even pre-Liberation Day on the U.S./ex U.S. dynamic.

Chris O’Malley: So, you saw AI stocks wobble a bit as we moved into the year, and that was driven by a couple of things. First, you had the DeepSeek model come out, and that model used much less processing power and came out at a much lower cost. And so, you know, many of these stocks that Julian was just alluding to that had driven all of the performance through 2024 took a pause, and we saw some profit-taking there.

The other thing that we had happened before broad-based tariffs were implemented where you had a lot of rhetoric related to tariffs coming out of the [Trump] administration. And remember, you also had tariffs put on both Canada and Mexico. And so, you did see stocks start to discount the risk of inflation and either a stagflationary or, worse, a recessionary environment in the U.S.

Castleton: And so, is that safe to say then, back then when that was occurring, equity valuations were pricing in the perfect scenario. And so, then that needed to be discounted into ex U.S. markets, potentially, which were much cheaper. Is that kind of what happened?

O’Malley: Absolutely, but also remember just how narrow U.S. markets were. You know, most of that valuation discrepancy, or a large part of it and a large part of that performance discrepancy, was being driven by a very small number of AI-related stocks.

Castleton: We’ve been talking to clients for a long time about cheap valuations in international markets. They do matter at some point, and this was clearly one of those moments in time where cheaper valuations worked out in our favor.

So, Julian, if I go back to you, a big portion of the outperformance has also just come from currency. So, can you comment maybe on the [U.S.] dollar in general, maybe not exactly where it’s going to go, but is that sustainable? Or what’s your view on the dollar going forward?

McManus: So, I can make an equity investor’s best effort here. And I’ll just start by saying that I’m glad that I only have to pick stocks. Currencies are, I think, the single hardest thing you can try to get right. And it’s extremely tricky because there are so many variables. But in the case of what’s going on with the dollar right now, I think it’s going to be dependent on policy.

And so, the problem is that policy right now has a lot of conflicting objectives. There are a number of different crosscurrents that you have to bear in mind, right. So, on the trade front, the Trump administration, on the one hand, wants a weaker dollar, and part of that is the fact that it’s a reserve currency, that’s working against their aims there. The problem is, again, in terms of contradictory aims, they recognize that the dollar can’t be the only reserve currency to solve this issue, but they also don’t want the RMB [Chinese renminbi] to be a reserve currency for the rest of the world. And so, there’s tension there. How they resolve that tension remains to be seen. It’s a tough nut to crack.

At the same time, you’ve had some fairly challenging policy ideas put out there by some of the Trump administration’s economists, such as the Mar-a-Lago Accord written by Stephen Moran late last year, and that’s opened a can of worms that’s going to be very difficult to resolve. It introduces the idea of renegotiating the terms of U.S. debt, and so, capital goes where it’s treated well, and you’re now seeing Chinese investors and Japanese investors both either let their bonds mature and not reinvesting them in Treasuries or just selling them all together. This is a problem for the dollar.

And so, you know, you’ve got all of these uncertainties, in addition to the fact that you also have the Fed [Federal Reserve] chair, his term ending a year from now and likely to be replaced by someone that’s more compliant to the Trump administration’s wishes. And so, what that means for rates and rate differentials is there are some wide error bands around that. So, the range of outcomes are very wide. And that’s why I come back to what I said, you know, I think calling currency here is going to be extremely difficult to do, and it’s something that we we don’t even attempt.

Castleton: Okay, so, that doesn’t mean you’re hedging all currency risk or not hedging at all. It’s just it’s pick the best stocks, find the best opportunity.

McManus: So, we’re agnostic as to what currencies are going to do. We pick the best ideas that we can express in the portfolio. And then we just use position sizing and portfolio construction to put together the portfolio in a way that there isn’t any significant currency risk we’re taking. And so, we we take care of that at the portfolio level.

Castleton: Got it, thank you for that.

Let me go to you again, Chris. So, again, May 30, we had a break, I feel like, from major tariff headlines once again. And now we are starting to see a tariff headline pick up again with the breakdown of talks with China. Who knows where this will be by the time of the release of this recording, but obviously, I think there will be continued ongoing uncertainty around tariff headlines. As you think about the opportunity set that you’re investing in, are there any opportunities that are more resilient to this volatility?

O’Malley: Absolutely. So, we still like European banks quite a bit. European banks are still growing earnings. As they grow earnings, they’re generating a lot of excess capital. They’re returning most if not all that excess capital back to shareholders. And we still think they look very cheap from a valuation basis. And best of all, they have virtually no exposure to tariffs.

Another area is European aerospace defense. It seems like Europe is on a trajectory to spend 3% to 5% of their GDP [gross domestic product] on defense going forward, or at least over the next decade. And again, little to no exposure to tariffs.

Where we do have exposure to tariffs, we’re just choosing to focus on those names that have pricing power, and so, they can pass those tariffs through to consumers.

Castleton: Clearly some industries a little bit more resilient; being active, being able to choose which ones to overweight right now is really crucial versus maybe just broad-based passive investing. It also, those industries that you brought up, [are] kind of antithesis to technology in the U.S. So, as you think about – Julian, to you – investing in international or ex U.S. stocks is not just because of their location, it also should be thought about in terms of style. Is that not correct?

McManus: Yes, that’s fair. So, style is one of the risk factors that we think about when we put the portfolio together. And being style agnostic, we actually very much deliberately balance value and growth at the same time in the portfolio so that what results is a core portfolio or a blend portfolio.

We think about that when we think about position sizing and the relative attractiveness of ideas that we have on the bench. We’re fortunate enough to have more ideas than we have room in the portfolio. And so, we’re able to just pick those that that actually make for the best fit so, that we’re not taking an extended bet either way on style, value, or growth.

Castleton: Yeah, that’s great. There are a lot of clients that are allocated to the international space and think they’re well diversified, but if they don’t have that blend of styles, they may not actually have that diversification that they’re looking for. So, staying core, getting exposure to value and growth seems crucial. All really good opportunities going forward.

Let’s just wrap this up, Chris, with you. So, if you look forward I guess, the biggest question is, is this sustainable? It’s been a really good five months, start to the year. We’ve had this before. So, what is your overall sense going forward of the sustainability of this trend? What could potentially derail us that investors should be aware of.

O’Malley: Look, we think a lot of the trends will remain in place regardless of what happens with administration policy here. For instance, in Europe, you know, I’ve mentioned defense spending. They’re going to spend a lot on defense going forward. They’re going to spend on infrastructure. Many of the fiscal brakes or forced balancing, I think, is going to go away and regulation will get rolled back, and that’s going to drive earnings growth in Europe.

In China, for instance, we think that the Chinese government will continue to be very supportive of economic growth or, you know, have put in place policies that are very supportive of economic growth going forward.

If you look out there on the risk front, you know, I think the biggest risk would be that the U.S. administration’s policies lead to a deep recession in the U.S., which would then pull the rest of the world in.

Castleton: OK. Well, thank you all. Any final thoughts before we go?

McManus: No, I just would echo what Chris has said. And I think that there’s a lot that can sustain above-trend growth in Europe, for example, both because of the taking off the fiscal debt brakes, but also the urgency around reform and driving growth in Europe. And then China, also in a similar way, the government has recognized recently the value of the role that the private sector has to play in driving economic growth. And so, I think you could have both of those engines working for some time.

Castleton: It does seem to be quite a different dynamic, with the U.S. really kind of needing to be a little bit more austere versus the rest of the world deregulating and potentially spending a little more. So, really thankful for you guys to walk us through what’s happened in the first five months of this year. We’ll see what happens but sounds like a constructive opportunity to be active in the ex U.S. space and consider that diversification.

And thank you all for listening. We hope you enjoyed the conversation. For more insights from Janus Henderson, you can download other episodes of Global Perspectives wherever you get your podcasts, or check out our website at janushenderson.com.

I’m Lara Castleton. Thank you, see you next time.