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, which would benefit international returns, if this were to occur, as international holdings get repriced into cheaper dollars.
- Relative valuation in a historical perspective favors EAFE, with both relative Price/Book and Price/Sales at historically low levels.
- At the end of May 2020, the S&P 500® Index closed at a price that was almost 100% above the 2007 peak and just 10% off the February high, while the MSCI EAFE Index was 28% below the 2007 peak and 16% below the February high. As the European and Japanese economies reopen, we see the potential for more gains. For the active manager, we believe there are many opportunities to uncover.
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.
- What looked like a temporary deceleration in economic growth in Europe and Japan in 2018 continued into 2019 as global trade volumes decelerated. 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®.
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, Federal Reserve, Bank of Japan, European Central Bank
This commentary is for informational purposes only and should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation to buy, sell or hold any security. There is no guarantee that the information is complete or timely. Past performance is no guarantee of future results. Investing in an index is not possible. Investing involves risk, including the possible loss of principal and fluctuation of value. Please visit touchstoneinvestments.com for performance information current to the most recent month-end.
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