March 20, 2018
Recently, the phrase “global synchronization” has been mentioned repeatedly in relation to the world’s major economies, which are growing in lockstep for the first time since the mid-2000s. In 2017, global stocks (or equities) strong positive returns and international stocks (MSCI ACWI – ex U.S.) finally outperformed their U.S. counterparts (S&P500). Currently, many investors are concerned that the opportunity for buying international stocks has passed, given the magnitude of performance these markets generated in 2017. However, as the U.S. bull market ages, prospects for international stocks are still compelling.
For the better part of the last decade, portfolios concentrated in U.S. stocks have been generously rewarded. Though rebalancing requires discipline—selling high-performing assets can be difficult, even for the most seasoned investors—we believe now is an opportune time for investors to consider shifting their focus internationally to benefit from attractive valuations, strong corporate growth prospects, and an earlier position in the economic cycle.
Non-U.S. stocks have generally traded at a discount to U.S. stocks over the last ten years on a forward price-to-earnings (P/E) basis, with the gap widening more recently. According to data from Standard & Poor’s and Morgan Stanley Capital International, the forward P/E ratio for developed and emerging international equities is now approximately 25 percent lower than U.S. stocks, almost twice the difference from ten years ago. Prices in the United States have far exceeded their historical averages and are approaching speculative territory. By nearly all measures, U.S. stocks have become expensive, creating opportunity for greater price appreciation outside of the United States.
While price is certainly an important consideration, the relative attractiveness of international stocks is reinforced by accelerated corporate earnings growth, particularly in developed Europe. Consumer confidence in the Eurozone has steadily improved over the last decade, reigniting economic activity. Low interest rates and negligible inflation have also created a supportive environment for corporate profit growth, sending business confidence to its highest level since August 2000.
The outlook for emerging market equities remains favorable, but given the strong performance among these countries in 2017, results going forward may be more muted. Furthermore, tightening by the Fed may cause headwinds as higher U.S. interest rates and a strengthening Dollar tend to put downward pressure on emerging market governments and corporate balance sheets. On the other hand, a continued decline in the U.S. Dollar often coincides with rising commodity prices, which typically bodes well for emerging market economies. While compelling opportunities still exist, stock selection will become increasingly important in emerging markets amid central bank policy uncertainties.
Without question, the United States is farther along in its recovery than countries outside of the U.S. International equities have not outperformed U.S. stocks meaningfully since 2009. If history serves as a guide, multi-year periods of underperformance from international stocks tend to be followed by years of outperformance relative to the U.S. equity market (the most prominent example was 2002-2007). The chart below illustrates these cycles.
While the bull market in U.S. stocks may not be over yet, from a relative performance standpoint, the tide seems to have shifted in favor of international equities. We believe economies outside of the U.S. are in the early stages of their recovery cycle and still offer significant appreciation potential. As such, an allocation to international stocks may provide additional diversification opportunities and boost portfolio returns over the next phase of the expansion cycle.
Dan Delany is an equities portfolio manager for CIBC Atlantic Trust Private Wealth Management with 21 years of industry experience. Prior to joining CIBC Atlantic Trust, he was a portfolio manager and investment analyst at Oak Ridge Investments in Chicago.
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