By Salvatore J. Bruno, Chief Investment Officer and Managing Director, IndexIQ
Ten years of economic growth in the U.S. has produced a decade of outperformance for U.S. equities as compared to a broad basket of international stocks. This phenomenon is starting to look like a permanent fixture on the investing landscape. But is it?
Reversion to the mean is a powerful force in the markets. We expect that will continue to be the case. Timing is another matter and, as long-term investors know, trends can persist much longer than logic might suggest. Clearly there are reasons the U.S. has outperformed. Corporate earnings have grown. The dollar has strengthened, rising nearly 28% for the 10-year period ending September 25, 2019, according to the Federal Reserve Bank of St. Louis. At the same time, Europe has been beset by a series of troubles, ranging from the Greek debt crisis to Brexit and has suffered collateral damage as a result of the U.S.-China trade war.
The divergence has become extreme, with European stocks now trading at historically low valuations relative to the U.S. (by some estimates, near 20-year lows). But there is some indication this is starting to change. Over the past three months momentum has shifted, with international developed markets outperforming the U.S. The ascension of Christine Lagarde to head of the European Central Bank suggests a more accommodative monetary policy going forward and a more dovish position on interest rates.
Europe generally, and Germany specifically, should benefit indirectly from a potential truce in the U.S.-China trade dispute and a step down in hostile trade rhetoric. Even the two-steps-forward-one-step-back Brexit negotiations have been looking somewhat more hopeful of late.
A recent piece in Morningstar noted that U.S. investors have about 24% of their investments allocated to international stocks, and 76% in U.S. stocks. This in spite of the fact that the U.S. equity markets comprise only about 45% of global stocks as measured by the FTSE Global All Cap Index. This has generally been a winning bet. In fact, Morningstar reports that since January 1995 through June of this year, the MSCI USA Index has outperformed the MSCI ex-USA Index by 4.3% a year.
But across that nearly 25-year period there have been extended times when international stocks outperformed. So, for multiple investing periods, exposure to developed international stocks added value to the portfolio. Capturing those potential returns requires a consistent strategy, and a long-term commitment to maintaining a level of international exposure. It reinforces again the benefits of diversification.
There are other reasons to consider reallocating some money to non-U.S. markets. Contrary to popular belief, U.S. multinationals don’t always provide the same level of diversification offered by a portfolio of international stocks. Global economic cycles are not always perfectly aligned. The Euro Zone, having lagged the U.S., may start to catch up. For those concerned about currency issues, an ETF using a 50% hedged approach can help lessen currency-driven volatility while allowing you to build a position in regions like Europe, Japan, or international broadly.
U.S. equity markets have outperformed for some time now, in part on the back of a stronger dollar. That may continue to be the case, but then again it may not. A reversal in the dollar, a revival of global trade that boosts Europe’s export-driven economies, or a shift in global stock sector performance could easily result in other markets outperforming the U.S.
It never hurts to be prepared for change. After all, it’s happened before.
Past performance is no guarantee of future results, which will vary. All investments are subject to market risk and will fluctuate in value.
This material represents an assessment of the market environment as at a specific date; is subject to change; and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the funds or any issuer or security in particular.
The strategies discussed are strictly for illustrative and educational purposes and are not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. There is no guarantee that any strategies discussed will be effective.
This material contains general information only and does not take into account an individual’s financial circumstances. This information should not be relied upon as a primary basis for an investment decision. Rather, an assessment should be made as to whether the information is appropriate in individual circumstances and consideration should be given to talking to a financial advisor before making an investment decision.
Reversion to the mean is a theory used in finance that suggests that asset prices and historical returns eventually will revert to the long-run mean or average level of the entire dataset. Assets that have outperformed their long run average tend to underperform over subsequent periods. The opposite is true for assets that have underperformed their long run average as they tend to outperform in future time periods.
The FTSE Global All Cap Index is a market-capitalization weighted index representing the performance of the large, mid and small cap stocks globally. The index aggregate of around 8,000 stocks cover developed and emerging markets.
The MSCI USA Index is designed to measure the performance of the large- and mid-cap segments of the US market. constituents, the index covers approximately 85% of the free float-adjusted market capitalization in the US.
The MSCI ACWI® (All Country World Index) Ex U.S. is a free float-adjusted market capitalization-weighted index that is designed to measure the equity market performance of developed and emerging markets, excluding the U.S.
The Euro Zone is a geographic and economic region that consists of all the European Union (EU) countries that have fully incorporated the euro as their national currency
“New York Life Investments” is both a service mark, and the common trade name, of the investment advisors affiliated with New York Life Insurance Company. IndexIQ® is an indirect wholly owned subsidiary of New York Life Investment Management Holdings LLC and serves as the advisor to the IndexIQ ETFs. ALPS Distributors, Inc. (ALPS) is the principal underwriter of the ETFs. NYLIFE Distributors LLC is a distributor of the ETFs. NYLIFE Distributors LLC is located at 30 Hudson Street, Jersey City, NJ 07302. ALPS Distributors, Inc. is not affiliated with NYLIFE Distributors LLC. NYLIFE Distributors LLC is a Member FINRA/SIPC.