Investing in the U.S. has been a worthwhile strategy over the years, but the markets are changing. With U.S. assets growing more expensive, investors should consider diversifying with overseas securities and related exchange traded funds.
“US stocks have become more expensive, especially compared with the rest of the world… The current premium on US stocks may be justified in the context of low inflation and low interest rates, but valuations look stretched relative to the rest of the world,” Russ Koesterich, Chief Investment Strategist for BlackRock and iShares Chief Global Investment Strategist, wrote for Financial Times.
The S&P 500 index’s price-to-book ratio is about 75% higher than the MSCI All Country World Index-ex US, the largest premium since 2003, according to Koesterich. Additionally, the cyclically adjusted price-to-earnings or Cape ratio is in the upper quintile of historical averages – when U.S. equities traded in similar historical levels, the markets experienced below average returns over subsequent five years.
According to Morningstar data, the S&P 500 index shows a 18.4 price-to-earnings ratio and a 2.6 price-to-book. In contrast, a broad all-world ex-U.S. index fund, like the Vanguard FTSE All-World ex-US (NYSEArca: VEU), has a 15.7 P/E and 1.6 P/B. Additionally, the iShares MSCI ACWI ex U.S. ETF (NasdaqGM: ACWX) has a 15.5 P/E and 1.5 P/B, and the SPDR MSCI ACWI ex-US ETF (NYSEArca: CWI) has a 15.0 P/E and a 1.5 P/B. [Turn to Europe, Japan ETFs for International Diversification]
The emerging markets show even cheaper valuations. For instance, the Vanguard FTSE Emerging Markets ETF (NYSEArca: VWO) 13.3 P/E and a 1.6 P/B, and the iShares MSCI Emerging Markets ETF (NYSEArca: EEM) has a 12.8 P/E and 1.5 P/B. [Emerging Market ETFs Could Begin to Outpace U.S.]
Additionally, as foreign countries contribute to a larger portion of the global economy, investors should consider the growing force overseas. The U.S. represented about a third of global output 30 years ago, but now the U.S. makes up about 20%.
“There is a more basic reason to bring down the significant US overweight evident in many portfolios: diversification still matters,” Koesterich added. “Over the long term, a more geographically diversified portfolio should lead to better risk-adjusted returns.”
The strategist pointed out that over the past three years, inter-country correlation has dipped to 0.53 or to pre-crisis averages. Consequently, investors may benefit more from international diversification now than the post-crisis environment.
For more information on investing around the globe, visit our global ETFs category.
Max Chen contributed to this article.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.