Sky-high valuations and weaker bounceback forecasts are just two of many factors pointing to the wisdom of a switch
For many investors in Canada, shedding their home bias means getting equity exposure to their North American neighbour to the south. But now it might be time to ask whether U.S. stocks have gone from being heavyweights to being just plain bloated.
American stocks have enjoyed great success compared to their counterparts around the world. Refinitiv Lipper data last year showed an average rise of 28% for U.S.-equity mutual funds and exchange traded funds, compared to 23% for international-stock mandates, according to the Wall Street Journal. This year until July, U.S. stock funds sank 2.1% on average, while international-stock funds declined 5.5%.
The 10-year stretch through July 31 saw the S&P 500 return 13.84% on an annualized basis, counting dividends. Meanwhile, the MSCI ex-USA Index of developed nations and the MSCI Emerging Markets Index advanced by 5.3% and 3.69% over the same period.
After that longstanding record of growth, it’s no surprise that U.S. stock valuations are as high as they are. Citing data from Morningstar Direct, the Journal said that as of July 31, estimates forward price-earnings ratios amounted to 23.84 for the S&P 500, 18.57 for the MSCI World ex-USA Index, and 15.84 for the MSCI Emerging Markets Index.
The argument for ex-U.S. diversification goes beyond that. Numerous emerging-market countries have, as well as many developed nations, have leapfrogged the U.S. in terms of progress in the fight against COVID-19. Amanada Agati, chief investment strategist for PNC Financial Services Group, pointed to the “gold standard” set in South Korea, as well as Spain’s and France’s proven ability to deal with a temporary shutdown.
While the country’s botched reopening may have endangered prospects of economic rehabilitation globally, it’s also helped put it behind many other countries in terms of emerging from coronavirus lockdowns. Coupled with the success of economic-stimulus plans put to work in numerous other nations, those advantages have fed into a consensus of relatively brighter prospects outside the U.S.
In a poll of analysts conducted by FactSet, respondents predicted that companies in the MSCI Emerging Markets Index will undergo a more modest earnings decline this year than those in the S&P 500. And while those analysts reportedly estimate a larger earnings drop among developed-market companies compared to those in the U.S., they also held that developed markets will see a bigger bounceback in earnings next year.
“With a long-term view of where the world’s growth is likely to emanate from, emerging markets is where you might like to place your bets,” Karim Ahamed, a financial adviser at Chicago- based Cerity Partners, told the Journal. Ahamed pointed to emerging markets’ younger populations, which should provide for faster labour-pool growth in those countries compared to developed nations.
A historical pattern in valuations may also be due for a repeat. Jeffrey Kleintop, chief global investment strategist at Charles Schwab, spoke of how the U.S. and foreign markets have consistently swapped places in terms of the direction of equity valuations at the end of each economic cycle. That pattern, which has played out over the last 50 years in cycles of roughly 10 years, suggests foreign stocks will outpace U.S. shares over the next decade.
“After a decade, whatever markets led in investor expectations get high in value, and then recession resets expectations,” he told the Journal. “Where expectations were highest, valuations come down the most.”
