The contrast between current economic momentum and monetary policy in the U.S. versus the rest of the world has led to lower valuations in international and emerging markets (EM) stocks -- but a change could be coming soon.
- A dichotomy exists between the U.S. and the rest of the world in terms of economic momentum and monetary policy -- one that's reflected in lower equity valuations for international developed and emerging markets.
- The outperformance of the U.S. vs international markets is cyclical and long lasting, with the U.S. having led since 2007. At this point in the cycle, history would suggest a reversal may be coming soon.
International Markets and Economies Still Playing Catch-Up
Global economies are so interconnected today that it makes sense to examine the fundamentals in regions outside the U.S. as a component of an assessment of the health of the domestic market and economy. In conjunction with our U.S. recession research, we have developed a dedicated international roadmap (Exhibit 1) that provides a high-level look at some of the factors impacting major economic regions around the globe.
This snapshot reveals a dichotomy between the U.S. and most of the rest of the world in terms of economic momentum and central bank policy. The U.S. was the first major market to recover from the global financial crisis. It also remains ahead of other regions in moving from accommodative monetary policy meant to spur growth to a more neutral policy stance that has included three consecutive years of interest rate increases. Europe, Japan and the rest of developed Asia, meanwhile, have retained easy monetary policy to keep their recoveries on track or avert recession. These actions have supported stable economic growth in Europe Ex-UK and accelerating growth in Asia Ex-Japan. Emerging markets are also experiencing stable growth while the UK and Japan have work to do to reverse decelerating growth trends.
Conditions Vary Around the World
Source: S&P, Moody’s, MSCI and Bloomberg. Data as of June 30, 2018. North America P/E and EPS growth based on S&P 500 data; all others based on respective MSCI Country/Region Indexes. 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.
The global economy has never been in better shape as measured by countries in recession. While recent weakness in Europe and China has raised concerns that the current period of synchronized global growth will be fleeting, ample liquidity and the ongoing transition toward a consumer economy in China will keep growth solid in the near to medium term.
Valuations in international markets have tended to reflect the pace of economic recovery, with all regions outside the U.S. trading at more attractive valuations. Looking at U.S. versus international equity markets, one has historically outperformed the other for long periods of time, anywhere from three to 10 years (Exhibit 2). U.S. stocks have been outperforming since 2009. Yet given the fact that most markets around the globe are earlier in their economic cycle and international markets are starting from lower valuations, we believe they have greater potential upside over the next several years.
U.S. vs International Equity: Net Difference in Performance in Percentage Points 1978-2017
Source: FactSet. Data shown covers period Jan 1, 1978 through Jan 1, 2018. US equity performance represented by S&P 500/Total Return. International stock performance represented by MSCI EAFE/Net Return. Figures in chart highlighting relative performance for specific periods represent net difference between indices over that specific period. 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.