Markets in Focus: Rate Cuts Ripple Through Export-Oriented Markets
Key findings
- Central bank policy shifts triggered a rebound in fixed income and previously underperforming equity sectors last quarter. Interest rate and currency fluctuations have notably affected export-oriented markets since hiking began.
- Global equity managers benefited from overweighting Japanese and European exporters throughout this period, as these firms outpaced their domestic peers on rising foreign demand.
- MSCI factor models indicate that certain countries and sectors are more exposed to currency fluctuations, suggesting close monitoring of economic exposures and foreign-sensitivity factor returns as monetary policy evolves.
Recent shifts in central-bank policies — especially those of the U.S. Federal Reserve — and their impact on currencies have combined with shifting trade relationships to renew concerns about export-oriented firms sensitive to both dynamics. In this quarter's edition of Markets in Focus, we examine the recent performance differences among export-oriented firms. Insights gleaned from this analysis could help risk managers and equity portfolio managers assess the impacts of evolving trade conditions and policy adjustments.
Positive performance trend in global markets continued amid volatility and rotation
Global markets maintained their upward trajectory in Q3, despite increased volatility in August and early September. The MSCI ACWI Index gained 6.7% for the quarter, bringing year-to-date gains in USD to 19.1%. Previously struggling sectors and asset classes rebounded over the summer.
The utilities and real-estate sectors were the quarter's performance leaders, while information technology (IT) and communication services trailed.[1] The sector rotation led to a decline in the dominance of the largest 10 U.S. stocks, with their combined weight dropping below 30% by the end of September, after peaking in early July. Additionally, small-cap stocks outperformed the broader market across several regions, perhaps in anticipation of lower inflation and interest rates.
Emerging markets (EM) outpaced developed markets, as China bounced back strongly with a 24% return in Q3 following the announcement of stimulus measures in late September. Among DM, Europe led returns, while U.S. stocks slowed relative to the first half of the year. And reversing their poor showing over the first six months of 2024, DM sovereign bonds (as measured by the MSCI Government Bond Index - Developed Markets) outperformed the MSCI World Index.
In the following video, Afsaneh Mastouri, head of fixed income solutions research at MSCI, discusses the impact of recent U.S. Fed policy shifts on fixed-income securities. She examines whether the asset class has regained its edge over equities after the recent rebound and highlights potential opportunities and warning signs.
Fixed income's comeback: What investors need to know
Fixed income and underperforming sectors in 1H 2024 outperformed in Q3
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Data as of Sept. 30, 2024. H1 2024 is defined as Dec. 29, 2023, to June 28, 2024. Q1, Q2 and Q3 refer to the quarterly returns in the respective quarters of 2024. Returns for the MSCI equity and fixed-income indexes are gross in USD. For 1-, 5- and 10-year performance data, please see MSCI's end-of-day index data search.
Considering these shifts in interest rates, countries and sectors, we next turn to the impact on one group in particular — export-oriented firms.
Mix of exported products may influence equity returns of exporters
We used the MSCI Equity Factor Models to analyze how firms in the key export-oriented markets around the world are faring in a deglobalizing world.[2] In particular, we relied on the foreign-sensitivity factor, which measures a firm's share of foreign sales and assets, to gauge the impact of recent changes in key interest and foreign-exchange (FX) rates in countries such as Japan, India, Canada and Australia, as well as on the economic exposures of companies in the European region, based on MSCI Economic Exposure data.
Export-oriented firms gained, as measured by the factor return, in Japan, India and Europe and lagged in Australia and Canada.[3] Japanese exporters enjoyed the largest increase in five-year annualized performance as compared to the prior decade. Countries in Europe and India benefited as well. The performance gap across markets over the most-recent five-year period could be explained by countries' different export mixes. Europe and Japan primarily exported manufactured goods, and the majority of India's exports were IT services. Exports by Canada and Australia consisted largely of natural resources such as energy products, minerals and agricultural commodities.
Returns from international exposure have increased in Japan and Europe since 2020
Data from January 2010 through September 2024. Time periods are from Jan. 1, 2010, to Dec. 31, 2019, and from Jan. 1, 2010, to Sept. 30, 2024. We show the annualized pure-factor returns of the foreign-sensitivity factor for Australia, Canada, India and Japan and the ex-Europe economic exposure for the European region. We calculated the return using the respective country/region models as specified in endnote 2.
Currency fluctuations have influenced the foreign-sensitivity factor's performance
Higher levels of international exposure helped generate positive returns for exporters in Japan, Europe and India over the last five years. To understand this better, we analyzed the relationship between currency movements and the foreign-sensitivity factor's performance following the 2008 financial crisis and throughout the era of the COVID-19 pandemic.
Currency movements — particularly against the USD — can significantly affect export sales.[4] Since 2010, factor returns in Japan, India and Europe were closely coupled with the valuation of the JPY, INR and EUR, respectively, against the USD.
Returns of factors measuring international exposure aligned with depreciating home currency
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Data from January 2010 through September 2024. We show the cumulative pure-factor returns of the foreign-sensitivity factor for Australia, Canada, India and Japan and the ex-Europe economic exposure for the European region. We calculated the return using the respective country/region models as specified in endnote 2. The right axis shows the spot rate against the USD for the JPY, INR and EUR, respectively.
IT and health care's foreign sensitivity could influence returns
If the direction ahead continues to be Fed rate cuts and potential appreciation of foreign currencies against the USD, small-cap and sector returns could be impacted. To learn more about how these parts of the market could be affected, we measured the foreign sensitivity of sectors and capitalization segments in Japan, India and Europe.
Utilities and real estate have been more domestically oriented than other sectors across the three markets. In contrast, export-oriented sectors, such as IT and health care, exhibited high foreign-sensitivity exposure in all three regions. Among small caps, all sectors have had a more-domestic focus compared to their large- and midcap peers, with IT and health care the exceptions in India, and energy in Europe.
If domestic currencies in Japan, India and Europe were to appreciate, companies in more domestically oriented sectors may be better positioned than other sectors, based on our analysis.
International exposure varied by sector across regions for small- and larger-cap stocks
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Central banks' policy choices will likely loom large for investors in the coming months. Risk managers and equity portfolio managers face the challenge of identifying which areas of their portfolios could be most affected, particularly by unexpected policy shifts. Factor models tailored to export-driven markets have highlighted wide differences in performance among exporter firms across regions, just over the last half-decade. Amid ongoing uncertainty, these models could provide useful insights about how stock returns might respond in various rate, currency and trade scenarios.
1 We define sectors following the Global Industry Classification Standard (GICS®). GICS is the industry classification standard jointly developed by MSCI and S&P Global Market Intelligence.2 The MSCI equity factor models incorporate economic exposures that reflect a firm's international sales outside its respective domicile. The models we used in our analysis were AUE5 (Australia), CALT (Canada), INE2 (India), JPNEFMLT (Japan) and EULT (Europe).3 Pure-factor performance refers to the return driven by a specific factor, net of other return drivers, such as market, industry and other style factors.4 In markets such as Japan, equity returns have often exhibited a negative correlation to the value of the home currency, implying that a depreciating currency has been typically associated with higher equity returns The correlation between the MSCI Japan Index in local currency and JPY strength has been negative since the global financial crisis, averaging -0.33 from Dec. 31, 1999, to Sept. 30, 2024.
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