The recent lag in U.S. stocks, bonds, and currency versus developed- and emerging-market peers was unexpected. (Editor's Note: For example, the iShares MSCI Emerging Markets Index after falling sharply last year, has gained about 10% in the past three months, a more than three-fold gain over the S&P 500.)

After all, the U.S. economy and markets had outperformed over the past year and were well-positioned entering 2014. This sharp reversal reinforces the case for diversifying portfolios internationally.

That being said, we continue to believe that U.S. financial markets will outperform international markets in 2014 and see in the U.S. pullback a chance to rebalance towards developed markets generally, especially U.S. markets.

So far this year, global equities have rotated amongst regions of the world, market capitalizations, and industry groups. One such move has been the swap out of U.S. and European equities, especially smaller company U.S. shares, into emerging- and other developed-international markets.

The relative weakness coincided with investors looking internationally for yield, after the strong run in U.S. and European equities over the past year. Europe's slow recovery and winter weather-related U.S. economic weakness also have cast some doubt as to whether U.S. and European economic growth this year will match expectations.

Monetary policy also has detoured investors. The Fed's continued commitment to keeping short-term interest rates near zero indefinitely, along with the recent decline in U.S. Treasury yields, have reduced the U.S. dollar's attraction.

Meanwhile, Japanese and euro-zone policy makers recently have failed to ease policy and so have disappointed investors looking for a more proactive approach. Together, low U.S. yields and uncertainty about policies in other major economies have detoured investors into emerging markets, where yields still exceed those in the largest developed countries and equity valuations look attractive, following last year's selloff.

Rotation into some developed and emerging markets should have been expected given the recovery in other areas such as the euro zone, but the recent rally seems an overreaction. First, forward-looking U.S., European, and Japanese economic fundamentals are strengthening, while those of the largest emerging markets are stagnant or still in decline. Brazil, Russia, and China all look weak, while India's case depends on how convincingly the newly elected prime minister can win support for a reform plan that could be painful in many parts of the country. Second, these weak fundamentals leave emerging markets vulnerable to a rebound in the U.S. dollar (once interest rates resume their path on our forecast uptrends), earnings growth for companies in the euro zone and its close trading partners, more than offsetting any depreciation in the euro.

Finally, we see more room to the top of our U.S. equity market target 6.0% than we see to our developed- and emerging-market targets (5.0% and - 1.0%, respectively).

Similarly, U.S. Treasuries have higher yields than Japan and most European countries and the spread is the highest it has been in over six years. While most developing-nation debt carries higher interest rates, the compensation for the added risk is close to the narrowest in the past year. In addition, the U.S. dollar looks to be in a nascent uptrend versus both developed and emerging peers but has pulled back versus both recently, providing a nice entry point.

As investors become less worried about the U.S. economy, these attractive fundamental factors will come back into play and the U.S. markets should once again take the lead.

 Investment recommendations


First, investors should take advantage of the opportunity to rebalance, considering the recent rallies across some developed- and emerging-market equities and bonds. Positions that exceed long-term targets can be trimmed at this point, with the proceeds rotated into U.S. markets, first, and a broadly diversified developed-market investment instrument.

Second, we also believe now is a good time for investors to implement our core-satellite approach to international and commodity investing which involves supplementing broadly diversified core positions with our satellite, or favorite, markets.

 Currently, our cautious stance leads us to emphasize markets with upcoming catalysts or defensive characteristics. Within developed markets, we prefer Germany, Sweden, Ireland, the Netherlands, and Austria, as we foresee the European Central Bank acting to support economic growth by September.

 With respect to emerging markets, we favor South Korea, Poland, Malaysia, and Taiwan as they are more fiscally sound than their developing counterparts and should outperform if emerging markets swoon again, as we expect. In commodities, we like the energy sector as the supply/demand outlook is the most constructive and any rise in risk premium could lead to further outperformance.


 Samana is an international strategist with Wells Fargo Advisors, the brokerage unit of Wells Fargo & Co.