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Ten years of economic growth in the U.S. has produced a decade of outperformance for U.S. equities as compared to a broad basket of international stocks. This phenomenon is starting to look like a permanent fixture on the investing landscape. But is it?
Reversion to the mean is a powerful force in the markets. We expect that will continue to be the case. Timing is another matter and, as long-term investors know, trends can persist much longer than logic might suggest. Clearly there are reasons the U.S. has outperformed. Corporate earnings have grown. The dollar has strengthened, rising nearly 28% for the 10-year period ending September 25, 2019, according to the Federal Reserve Bank of St. Louis. At the same time, Europe has been beset by a series of troubles, ranging from the Greek debt crisis to Brexit and has suffered collateral damage as a result of the U.S.-China trade war.
The divergence has become extreme, with European stocks now trading at historically low valuations relative to the U.S. (by some estimates, near 20-year lows). But there is some indication this is starting to change. Over the past three months momentum has shifted, with international developed markets outperforming the U.S. The ascension of Christine Lagarde to head of the European Central Bank suggests a more accommodative monetary policy going forward and a more dovish position on interest rates.
Europe generally, and Germany specifically, should benefit indirectly from a potential truce in the U.S.-China trade dispute and a step down in hostile trade rhetoric. Even the two-steps-forward-one-step-back Brexit negotiations have been looking somewhat more hopeful of late.
A recent piece in Morningstar noted that U.S. investors have about 24% of their investments allocated to international stocks, and 76% in U.S. stocks. This in spite of the fact that the U.S. equity markets comprise only about 45% of global stocks as measured by the FTSE Global All Cap Index. This has generally been a winning bet. In fact, Morningstar reports that since January 1995 through June of this year, the MSCI USA Index has outperformed the MSCI ex-USA Index by 4.3% a year.
But across that nearly 25-year period there have been extended times when international stocks outperformed. So, for multiple investing periods, exposure to developed international stocks added value to the portfolio. Capturing those potential returns requires a consistent strategy, and a long-term commitment to maintaining a level of international exposure. It reinforces again the benefits of diversification.
There are other reasons to consider reallocating some money to non-U.S. markets. Contrary to popular belief, U.S. multinationals don’t always provide the same level of diversification offered by a portfolio of international stocks. Global economic cycles are not always perfectly aligned. The Euro Zone, having lagged the U.S., may start to catch up. For those concerned about currency issues, an ETF using a 50% hedged approach can help lessen currency-driven volatility while allowing you to build a position in regions like Europe, Japan, or international broadly.
U.S. equity markets have outperformed for some time now, in part on the back of a stronger dollar. That may continue to be the case, but then again it may not. A reversal in the dollar, a revival of global trade that boosts Europe’s export-driven economies, or a shift in global stock sector performance could easily result in other markets outperforming the U.S.
It never hurts to be prepared for change. After all, it’s happened before.
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