From the end of 2008 to the conclusion of 2018, the U.S. markets significantly outperformed international developed markets. The S&P 5001 averaged a 13.1 percent return annualized during this period versus 6.8 percent2 for the MSCI EAFE Index3, which represents major international equity markets across developed countries in Europe, Australasia and the Far East.
Part of this outperformance was due to U.S. assets being more cheaply valued at the bottom of the downturn. Part of it was due to the U.S. economy having higher and more consistent growth than other developed markets over this period. However, this 10-year snapshot tells only a part of the story of the interaction between U.S. and international markets.
Over nearly five decades from 1970 through the end of 2018, the two indexes produced similar returns (9.1 percent a year for the EAFE2 vs. 10.2 percent for the S&P 5001). Taking the last 10 years out of the equation is even more illuminating, as the EAFE and S&P performed almost identically (9.7 percent per year2 vs. 9.5 percent1, respectively) between 1970 and 2008.
In a global marketplace, similar returns across developed markets are expected. When capital can flow freely between markets to where it will be best rewarded, long-term returns of similar-risk assets should be about the same. If a particular country is seen as riskier (as the U.S. was in late 2008) then prices there will fall to account for that extra risk. This can include geopolitical tensions, government mistakes and corruption, currency weakness, slower economic growth and other factors.
The U.S. has benefited from a more dynamic economy than most international markets, but it is important to understand that prices largely account for those advantages already. For example, compared to U.S. corporations, internationally domiciled companies are being discounted at a rate of 20-50 percent, 4 depending on the valuation metric. In some cases this discount belies growth prospects in international countries.
Looking at earnings growth, emerging market earnings are expected to grow at a slightly faster clip than the U.S. while international developed markets are expected to grow slightly more slowly. As noted in the chart below, Goldman Sachs has estimated that S&P growth this year will reach about 8 percent, with emerging markets at approximately 9 percent and developed markets at about 7 percent.
Additionally, as indicated in the above chart, the S&P currently trades at a forward price-to-earnings (P/E) ratio5 of 17.1, much more expensive than the 11.6 for emerging markets. International developed markets represented by the EAFE have a forward P/E ratio of 13.3. Looking at these prices we can see that more risk has been priced into international assets.
Historically, U.S. and foreign markets have had very similar returns over longer periods of time while they switch back and forth from outperformance to underperformance during shorter periods. Being diversified across markets keeps us from being too dependent on any one market, currency and economy when the situation in one area of the globe inevitably changes.
1. Yahoo! Finance – S&P 500
2. DFA Returns
3. Investopedia – EAFE Index
5. Investopedia – Forward price-to-earnings – Forward P/E definition
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