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Currency Depreciation: A Rational Response to Tariffs?

The US dollar’s rise since September cut into international markets. Of the 7% decline in international markets in the fourth quarter, the vast majority of it can be attributed to currency depreciation against the dollar.

For countries facing harsh new tariffs from the US, weakening the currency is a highly rational response: What tariffs take away in competitive pricing from other countries, currency depreciation restores with little cost to the domestic economy, keeping products competitive in the destination market. In other words, currency depreciation negates the disinflationary effects of a strong dollar as offsets to the inflationary effects of tariffs.

If a country has few other considerations (such as high foreign debts), that trade-off is fairly painless and blunts the potency of the tariffs to alter any other policy or behavior. So far that’s not what you see in this recent spate of currency depreciation: The two countries currently facing the severest threats from additional US tariffs are China and Mexico, but neither of those currencies exhibited much weakness during the fourth quarter as seen in the above chart. However, in the longer term, we think currency depreciation may not be such a bad thing for the US’s trading partners.

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Japan’s Mid-Quarter Market Turmoil Ends in Recovery for Fast-Growing Small Caps

An unexpected interest-rate increase from the Bank of Japan helped ignite a market firestorm during the third quarter.

The central bank’s decision in late July caused a swift appreciation in the yen, a currency shift that disrupted the widely used strategy known as the yen carry trade, where investors borrowed at low Japanese rates to purchase higher-yielding foreign assets. The rapid unwinding of these positions, combined with weaker US economic data and disappointing earnings from US technology giants, culminated in a 12% drop in Japan’s Nikkei index on August 5, while expected volatility in the US equity market spiked to a level not seen outside of major crises.

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Chinese Stocks Get a Jolt

Chinese stocks in September had their best week since the 2008 financial crisis after officials unveiled a new set of stimulus measures. The MSCI China Index surged 25% in just the last nine trading days of the third quarter, erasing 20 months’ worth of losses. Unlike other stimulus measures over the previous two years, this one was more comprehensive and included two key financial measures: a 50 basis point cut in the reserve requirement ratio for banks and a 20 basis point drop in the seven-day reverse repo rate.

There were additional measures aimed at boosting the real-estate sector, which rebounded by about 50% in late September, as seen in the chart below. The policy announcements included cutting mortgage rates for existing homeowners by as much as 50 basis points and cutting the down payment requirement for second home purchases by 15%.

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Why Own International Stocks?

For more than a decade, equity returns in international markets have trailed those of the US. There are various possible explanations, but a central one is that the US, after first staging a faster recovery from the global financial crisis, has tended to produce stronger earnings growth in the years since. Meanwhile, from an international perspective, everything from a strong dollar to geopolitical conflict to volatility in emerging markets to China’s economic slowdown have weighed on relative returns. It also doesn’t help that the arrival of ChatGPT, and the enthusiasm and competition it has inspired for generative artificial intelligence technology, has lately encouraged an almost singular focus on a handful of US tech stocks—out of nearly 2700 index constituents, a mere 0.2% of the companies in the MSCI ACWI Index.

Some investors look at the difference between international and US returns and, expecting that current conditions will persist, wonder what place non-US equities have in a portfolio today. But while it’s easy to fall into that line of thinking, history suggests it is likely wrong. The relative performance of US and non-US stocks has historically been a cyclical phenomenon, and as the chart below shows, their indexes have regularly swapped between leader and laggard over the past 50 years.