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Second Quarter in Non-U.S. Stock Funds: Uncertainty Abounds

Trade drama threatened to derail international stock funds following a strong first quarter.

International equity funds encountered a much different investment climate in the second quarter of 2019 than in the first. After calming in the first quarter, macroeconomic and geopolitical risks increased, raising tension and volatility in the markets. Still, the end results were middling at worst. The MSCI ACWI ex USA Index rose 3.0% in U.S. dollar terms for the quarter and was up 13.6% for the year. The MSCI EAFE Index of developed markets beat the MSCI Emerging Markets Index for the second consecutive quarter. Its 14.0% return thus far beat the MSCI Emerging Markets by 3.4 percentage points.

U.S. equities continued outperforming international equities. The MSCI ACWI ex USA Index has lagged the Russell 3000 Index in 65% of the past 40 quarters. Furthermore, the U.S. index’s margin of victory in its winning quarters was bigger than that of the non-U.S. index.

The effects of escalating U.S.-China trade tensions were widespread. The countries traded tit-for-tat tariff hikes after trade talks broke down in May, damping global macroeconomic outlooks, and prodding central bankers to announce they stood ready to prime the economic pump with additional stimulus in the event of a recession.

Despite the change in sentiment, the six non-U.S. Morningstar Categories finished in the same order as they did in the first quarter. The foreign large-growth category and the foreign small/mid-growth category led the way, with the former gaining 4.8% and the latter 4.1% in U.S. dollar terms for the quarter. The foreign large-value category and foreign small/mid-value category added 1.8% and 0.7%, respectively. The foreign large-blend category and foreign small/mid-blend category landed in the middle. For the year, the foreign large- and mid/small-growth categories trounced their respective value counterparts by over 7 percentage points.

China lost 3.1% for the quarter, the worst among non-U.S. equity categories. Chinese giants Tencent 00700 and Alibaba BABA, which make up over one fourth of the MSCI China Index, both finished lower for the quarter. Matthews China Dividend MCDFX, which earns a Morningstar Analyst Rating of Bronze, provided ballast. This lower-volatility strategy lagged the MSCI China Index’s 17.7% first-quarter gain but lost 3.4 percentage points less in the second quarter. All told, the fund beat the benchmark by 2.5 percentage points for the year to date. Japan lagged, too, losing 0.1% amid concerns that trade tensions would further weaken the Japanese economy.

Brexit added uncertainty. The European Union extended the deadline for Britain to leave the EU by six months, but discord remains. The extension highlighted growing divisions among EU countries about how to deal with a muddled United Kingdom, which is scrambling to select a new prime minister after Theresa May resigned when her Brexit deal failed to win Parliament’s approval for the third time. The turmoil also forced investors to grapple with the probability of another deadline extension or the U.K.’s disorderly withdrawal from the EU.

Still, developed European countries, such as Switzerland, France, and Germany, pushed European equities up 4.4% for the quarter. Bronze-rated Artisan International ARTIX rebounded following a poor first quarter thanks to German-based Wirecard WDI and adidas ADS, and Swiss company Nestle NESN. Indeed, the fund’s 19.3% gain for the year to date finished in the top half of the foreign large-growth category after lagging in the first quarter. Meanwhile, Neutral-rated foreign large-value fund Templeton Foreign TEMFX lost 0.4% in the second quarter and trailed 96% of category peers in 2019. Chinese stocks, such as Baidu BIDU, China Telecom 00728, and China Mobile 00941, posted outsize losses for the quarter while top-10 holding Teva Pharmaceutical Industries TEVA shed almost two thirds of its value in the past year due to increased competition, high financial leverage, and a litany of opioid-related lawsuits.

Concerns about supply, demand, and security whipsawed oil prices and had divergent effects on developing countries. Latin American equities led the way, finishing up 7.1% for the quarter, while India and China dragged on returns. Owning U.S. and European companies with emerging-markets economic ties and a lot of Brazilian firms helped Bronze-rated Artisan Developing World APHYX continue its torrid start to the year. The fund’s 30.9% gain for the year to date led the diversified emerging-markets category and beat the category average by 18.7 percentage points.

With a wide range of allocations and investment styles, global equity fund returns varied. The MSCI All Country World Index (ACWI), with over half its assets in U.S. equities, was up 16.2% for the year to date. Neutral-rated Templeton Growth TEPLX suffered because it kept just one third of its assets in U.S. equities and, despite its name, has a value-oriented approach. Indeed, the fund lagged the index by 8.6 percentage points in the first two quarters. Meanwhile, Bronze-rated Morgan Stanley Institutional Global Opportunities' MGGIX aggressive growth picks and larger U.S. allocation helped it beat 97% of its category peers with a 26.0% gain so far in 2019.

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