Things Change: The Case for International

Things Change: The Case for International

International equities could regain momentum as conditions that have favored U.S. stocks begin to shift.


Some ask “why go international?” because the U.S. has outperformed the rest of the world by so much for so long.  But if you look back, international performance was very strong from the years 2002, 2003, with international outperforming the U.S. by a factor of two, roughly.  And then, after similar declines during the financial crisis, something happened, performance diverged very, very dramatically from 2010, 2011 onwards with the U.S. outperforming international by a large factor.

 

What could a reversal mean?

Chart: MSCI All Country World ex-US and S&P 500 Index

Sources: MSCI, Standard & Poor’s, FactSet, J.P. Morgan Asset Management. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment. Forward price to earnings ratio is a bottom up calculation based on the most recent index price, divided by consensus estimates for earnings in the next twelve months (NTM), and is provided by FactSet Market Aggregates. Returns are cumulative and based on price movement only, and do not include the reinvestment of dividends. Dividend yield is calculated as consensus estimates of dividends for the next twelve months, divided by most recent price, as provided by FactSet Market Aggregates.

 

There were a few reasons for that. First, central banks overseas reacted much later than the U.S.  The U.S. started right after the financial crisis and didn’t take the foot off the pedal—whereas the European Central Bank—put the foot on the brakes and restarted in 2015.  So international markets are definitely behind in terms of recovery versus the U.S.

Second, the U.S. market did better because of a greater weighting in technology—which was a big winner in recent years. 

Third, U.S. company return on equity (ROE) has been higher compared with international, and a good part of that has come through share buybacks.  U.S. companies in general have done extremely well through their share buybacks and put even more debt on their balance sheet in order to afford more share buybacks. That’s pushed up ROE and valuations.

Fourth, but not least, was the Trump effect, including the tax cuts which pushed up U.S. equities even further. 

So where does it lead?  Money has flowed to U.S. equities and U.S. bonds and in U.S. currency. 

If that were to reverse as we saw in 2002, 2003, it would be very, very powerful for international markets. In terms of valuations, the U.S. is not hugely expensive, but a bit more expensive than the 20-year average in the S&P 500.  On the international side, things are less expensive, but not by a big margin.

If you look at dividend yields, they’re lower in the U.S., but compared to 10-year bonds, there’s a negative yield spread. That’s the opposite of the international markets where bond yields are sometimes minus or just above zero and we get a positive spread.  Currencies could also be another factor which moves international.   

Trade and tariff tensions

Conclusion of the trade war would definitely be positive for international markets.  If the trade war intensifies, it would be logical for China to conduct further stimulus. It might also devalue the yuan, which could be a little bit ugly for the rest of the world. 

It’s uncertain when the trade war with China will end, but the longer it lasts, the bigger the impact on economies and stock markets.  And remember, what’s happening with the U.S. and China isn’t the only tariff dispute that’s ongoing. There are issues with Canada, with Europe, particularly on autos, and with the Japanese as well.  The upcoming 2020 election in the U.S. may be an incentive for President Trump to find resolutions sooner rather than later. The G20 meeting in Osaka, Japan at the end of June may bring some clarity.

At the end of the day, everybody pays for tariffs. There is the direct impact on consumers and a secondary impact on market sentiment, which is more difficult to measure. If confidence and sentiment sours, corporations will not invest more for growth. That’s already visible in capital expenditures, so we need confidence back with respect to trade and economic growth for corporations to want to make long-term capital allocation decisions and for the stock market to react positively.


Any information, statement or opinion set forth herein is general in nature, is not directed to or based on the financial situation or needs of any particular investor, and does not constitute, and should not be construed as, investment advice, forecast of future events, a guarantee of future results, or a recommendation with respect to any particular security or investment strategy or type of retirement account. Investors seeking financial advice regarding the appropriateness of investing in any securities or investment strategies should consult their financial professional.

Definitions:

Dividend yield is a financial ratio that shows how much a company pays out in dividends each year relative to its share price.

The Group of Twenty (also known as the G-20 or G20) is an international forum for the governments and central bank governors from 20 major economies. The members include 19 individual countries—Argentina, Australia, Brazil, Canada, China, France, Germany, India, Indonesia, Italy, Japan, Mexico, Russia, Saudi Arabia, South Africa, South Korea, Turkey, the United Kingdom and the United States—along with the European Union (EU). The EU is represented by the European Commission and by the European Central Bank.

The Morgan Stanley Capital International (MSCI) All Country World Index (ACWI) ex USA Index captures large and mid-cap representation across 22 of 23 Developed Markets (DM) countries (excluding the US) and 24 Emerging Markets (EM) countries.

The price-to-earnings (P/E) ratio is a stock's (or index’s) price divided by its earnings per share (or index earnings).

The forward P/E ratio is a stock’s (or index’s) current price divided by its estimated earnings per share (or estimated index earnings), usually one-year ahead.

Return on Equity (ROE) is the amount of net income returned as a percentage of shareholders equity. Return on equity measures a corporation's profitability by revealing how much profit a company generates with the money shareholders have invested. ROE is expressed as a percentage and calculated as: Return on Equity = Net Income/Shareholder's Equity

The S&P 500 Index is an unmanaged index of 500 stocks that is generally representative of the performance of larger companies in the U.S.

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