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Written by: Gabriela Santos and Anjali Balani, Corey Hill
Investors tend to find reasons to avoid international equities – either the U.S. economy is doing too well or it might be going into a recession. Is it true that international equities sell off more than the U.S. does during market corrections? Looking back over the past six occurrences helps to burst the myth that “when the U.S. sneezes, the rest of the world catches a cold”. What matters most is the relative valuation starting point going into the sell-off. Despite outperforming the U.S. since October, international equities still have double the discount to the U.S. as normal. This suggests both upside and downside benefits to increasing international equity exposure in portfolios.
While enthusiasm about a U.S. soft landing and pessimism about the rest of the world is elevated, international equities have proven hard to ignore. International indices have outperformed the U.S. in both local currency and dollar terms over the past year. Importantly, they have also done so with far wider market breadth: if one assigns equal weights to the MSCI Europe, Japan and the U.S. indices, 2023 has been the best start to a year for international markets since 1998. Meanwhile, AI euphoria has pushed U.S. market concentration to its highest levels since the 1960s. Finally, while U.S. investors have been rewarded to look no further than home when investing in the past decade, international markets have delivered (on average) half of the 50 best performing stocks globally in every calendar year over the past 20 years. While headlines can point to U.S. stocks leading the charge, it can result in missing some of the best performing stocks globally.
Inevitably, the pendulum will eventually switch back to U.S. recession concerns. What’s more, history shows that 10% U.S. equity market corrections are to be expected on any given year. Investors often fear that in these situations, sell-offs in international markets will be even stronger than those in the U.S. However, looking back at the past six U.S. stock market declines greater than 10%, international has not always sold off more. In some instances, it has performed in line or even better.
What is more helpful is analyzing the relative discount or premium of international versus the U.S. going into a correction – and how much it would have to sell off to return to average. Comparing actual versus theoretical selloffs shows that international equities have performed as expected. 2022’s bear market was the one exception: international sold off as much as the U.S., but much more than expected given its large initial discount. The War in Ukraine and Zero COVID policy in China likely explains this, rather than Fed-induced hard-landing fears alone.
What should investors expect next time “hard-landing” fears resurface? Given today’s starting point, international equities may hang in better than the U.S. (if the main concern is a U.S. recession): international equities still have double their long-run discount (33% vs. 16%). Europe, in particular, has outperformed; however, this has been driven by diversified sources, including currency and earnings: two components that give us confidence in the sustainability of that outperformance.
Against this environment, particularly one with ongoing recession anxiety, investors could not only to capture more upside than the U.S. from here, but also potentially to hedge more on the downside during U.S.-driven corrections.
Contrary to the myth, international markets do not always underperform during sell-offs
USD, price return
Source: MSCI, Standard & Poor's, J.P. Morgan Asset Management. Data are as of August 2, 2023.
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