Author: Tim Courtney
International markets have continued to lag behind the U.S.1 The last calendar year in which international equities outperformed U.S. equities was 20172 and that happens to be about when the trade disputes – which started in early 2018 – began in earnest.3
There have been two main fundamentals that have driven this performance gap, and we’ll examine these factors and evaluate the importance of international equity exposure.
● Currency: The recent strong dollar has been a key reason the U.S. has eclipsed international markets over the last decade.4 The U.S. Dollar Index moved from 80.72 on March 19, 2010 to 102.82 on March 20, 2020, an increase of 27%.4 As our returns are calculated in U.S. dollars, a good portion of U.S. outperformance over the last 10 years can be attributed to the appreciation of our domestic currency.
This currency strength has helped to maintain our purchasing power as consumers.5 However, we probably can’t count on an ever-strengthening dollar to boost our returns and purchasing power. The dollar has generally declined against foreign currencies over the last 35 years, and the extreme level of current spending and potential new currency supply are headwinds for the U.S. dollar.6 In addition, many in the U.S. (especially those who sell U.S. goods and services overseas) are arguing for a weaker dollar to help grease trade and exports.
At Exencial, we would expect the dollar to revert back to its mean, as most assets eventually do. If it does, we will feel it as consumers as inflation heats back up, but international assets will likely provide some relief as their returns would be, all other things being equal, higher.
● Valuations & Fundamentals: In addition to currency appreciation, U.S. outperformance has been bolstered by faster earnings growth and increasing valuations in key sectors, notably technology.7
While we believe U.S. companies should command better valuations compared to their international counterparts, we don’t think the widening gap between high U.S. and lower international valuations is entirely due to fundamentals. Historically, higher-priced assets have lower expected returns than lower-priced assets. As such, we are estimating international equities to have higher expected returns moving forward.
The U.S. markets and the dollar have performed well over the last decade and we believe we will see very acceptable returns from U.S. stocks in the next decade. However, history has shown that relative performance tends to eventually revert to its mean. If relative performance never reverted to mean, it could be for one of two reasons: an investment has ongoing advantages that are consistently misunderstood and not reflected in current prices, or markets have malfunctioned and are offering something like a free lunch. We don’t think either of these are very likely and recommend exposure to diversifying assets such as international stocks.
If you have any questions about your portfolio allocations, please feel free to reach out to your advisor anytime.
1. Yahoo! Finance (data as of 6/24/20) – iShares MSCI ACWI ex U.S. ETF (ACWX)
2. Yahoo! Finance (data as of 6/24/20) – S&P 500
3. BBC News (1/16/20) – A quick guide to the US-China trade war
4. MarketWatch (data as of 6/24/20) – U.S. Dollar Index (DXY)
5. Investopedia (3/19/20) – Strong dollar: Advantages and disadvantages
6. CNBC.com (6/22/20) – Will Americans get another round of stimulus payments? Your top questions answered
7. Markets Insider (6/23/20) – US stocks climb, Nasdaq hits record as investors pile into tech giants
The US Dollar Index is used to measure the value of the dollar against a basket of six world currencies - Euro, Swiss Franc, Japanese Yen, Canadian dollar, British pound, and Swedish Krona. The value of the index is fair indication of the dollar’s value in global markets.
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