International Developed (EAFE) vs. U.S.
Investing in developed international stocks has historically provided investors with:
- Diversification: portfolios that included international stocks have historically produced higher risk-adjusted returns (Flavin and Panopoulou).
- Opportunity: 77% of publicly traded companies are not U.S.-based (Source: MSCI) and 59% of the global market cap resides outside of the U.S. (Source: Bloomberg). Why limit equity exposure to just a fraction of the total market opportunity set?
But why now...
Conclusion: Much like the Value versus Growth picture we see supportive valuation for international stocks and the prospect of a strong cyclical earnings rebound versus U.S. stocks, but we see longer term structural fundamental issues that may preclude longer term outperformance. Once this crisis fully abates, we do see the potential for a weaker U.S. dollar. If this were to occur, it would benefit international performance as the local currency returns get repriced into cheaper dollars.
Relative valuation in a historical perspective clearly favors EAFE, though versus its own history EAFE is not terribly cheap. Still, for the active manager, we believe there are many opportunities to uncover. And when social distancing goes away, we expect the more cyclical EAFE index to outperform U.S. stocks. A trade deal between the EU and UK, instead of a no-deal Brexit, is also a positive and gives companies a platform from which to make investment spending decisions. Something that has been on hold for some time.
Relative Valuation Measures
Based on the MSCI EAFE Index/S&P 500® Index as of November 2020
|Price/Trailing 10 Year EPS||1|
|Summary Signal (Average)||1|
*Average of the five relative valuation measures
Sources: Bloomberg, MSCI
Relative Earnings Prospects
- Relative price performance and relative earnings growth have historically followed a similar path. Relative earnings growth since mid-2008 has favored the S&P 500® Index versus the MSCI EAFE Index until mid-2016.
- MSCI EAFE Index earnings began to outpace the S&P 500® Index in 2017. But since then, S&P 500® earnings have done better due to the tax cut in 2018 and due to relative economic performance in 2019 and 2020. Unfortunately, other structural issues such as demographics, a weak banking system, and seemingly permanent negative interest rates continue to disadvantage MSCI EAFE earnings relative to the S&P 500®. Still analysts project EPS outperformance in 2021 and 2022 for the MSCI EAFE due to the anticipated economic rebound from the COVID crisis.
Sources: Bloomberg, MSCI
- The Fed and U.S. government has been much more aggressive than other developed nations creating a more positive backdrop for the relative performance of U.S. stocks. In a recovery, a portion of the aggressive stimulus could be given back through a weaker currency.
- Historically the U.S. dollar typically moves directionally with U.S. stock relative performance. This has not been the case over the last couple of years. A sustained period of U.S. dollar weakness would provide a tailwind for international stocks.
Sources: Bloomberg, Intercontinental Exchange
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