By Tim Courtney, Chief Investment Officer

It’s no secret that American stocks have been outpacing their European counterparts. While U.S. large cap markets are wrapping up some of the highest 5 and 10 year returns ever (16% and 13% annualized respectively), international markets over the last 5 and 10 years have produced mediocre returns of 8% and 6% annually.¹ This divergence is stark considering that over longer time periods the returns of European/international and U.S. markets have been very similar.

Since the inception of several international indexes in 1970 through 2007, the S&P 500 returned 11% annually compared to 12% for the MSCI Europe and EAFE Indexes.¹ Returns began favoring the U.S. following the 2008 global financial crisis. It is normal for returns to diverge and helpful for diversification purposes. In fact, the U.S. and international markets have taken turns as the outperforming market multiple times over the last 55 years. But the magnitude of the divergence since 2008 is unprecedented.

One reason for this is that the fallout from the Great Financial Crisis hit international markets and profits much more forcefully than it did in the U.S. International indexes have higher weights to banks and financials than indexes in the U.S.² Post crisis, the U.S. has been able to lean on other sectors to drive returns, like tech and communications. European markets have lower weights to these profitable sectors and did not easily pivot.³ Another major reason for the divergence has been the strength of the U.S dollar, which is up 34% against other currencies since 2007.⁴ 

These two forces though – U.S. earnings superiority and dollar strength – have greatly weakened since the pandemic. From April 2020 until now earnings growth in Europe has equaled earnings growth in the U.S., and the dollar is just slightly higher against other currencies.⁵ Still, the S&P 500 is up about 140% over that time frame compared to about 90% for European/international markets.¹ These are great returns over just 4.5 years’ time, but the divergence persists.

What is happening to these two markets? First, the U.S. market has become much more expensive than the international market. This happens as the price of one market (the U.S.) moves higher much faster than its earnings. Secondly, those prices are moving higher because U.S. investors are assuming that we are on the threshold of an AI boom in profitability and productivity. So far, spending on generative AI continues to accelerate with not much to show for it, although there certain some areas in which AI is helping improve productivity.⁶

Whether you consider price to cash flow, price to book value, price to sales, price to dividend, etc., price has historically been a good predictor of future returns. The higher the price, the lower the expected returns are typically. Being diversified means owning some of the more expensive parts of the market, but also owning parts of the market that are more normally priced, such as today’s international markets following a divergence in recent returns. If you have any questions, please contact your Exencial advisor.

Sources:

1. DFA Returns 2.0 Data (as of 9/30/24) – MSCI EAFE Index GD, MSCI Europe Index GD, S&P 500 Index TR
2. Investing for Beginners (7/12/23) – Historical S&P 500 Industry Weights – [20+ Year History]
3. STR (10/9/20) – Europe’s recovery from the last recession
4. WSJ.com (9/30/24) – U.S. Dollar Index (DXY)
5. Goldman Sachs Market Update (08/05/24) – S&P 500 vs STOXX 600 Earnings Growth per Share via Bloomberg
6. Seeking Alpha (9/10/24) – Nvidia: AI Is Not Translating To Higher Corporate Earnings

PAST PERFORMANCE IS NOT AN INDICATION OF FUTURE RETURNS. Information and opinions provided herein reflect the views of the author as of the publication date of this article. Such views and opinions are subject to change at any point and without notice. Some of the information provided herein was obtained from third-party sources believed to be reliable but such information is not guaranteed to be accurate. In addition, the links provided within are for convenience only and the provision of the links does not imply any sponsorship, endorsement, or approval of any of the content. We do not guarantee the content or its accuracy and completeness. The content is being provided for informational purposes only, and nothing within is, or is intended to constitute, investment, tax, or legal advice or a recommendation to buy or sell any types of securities or investments. The author has not taken into account the investment objectives, financial situation, or particular needs of any individual investor. Any forward-looking statements or forecasts are based on assumptions only, and actual results are expected to vary from any such statements or forecasts. No reliance should be placed on any such statements or forecasts when making any investment decision. Any assumptions and projections displayed are estimates, hypothetical in nature, and meant to serve solely as a guideline. No investment decision should be made based solely on any information provided herein and the author is not responsible for the consequences of any decisions or actions taken as a result of information provided in this book. There is a risk of loss from an investment in securities, including the risk of total loss of principal, which an investor will need to be prepared to bear. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be profitable or suitable for a particular investor’s financial situation or risk tolerance. Exencial Wealth Advisors, LLC (“EWA”) is an investment adviser registered with the Securities & Exchange Commission (SEC). However, such registration does not imply a certain level of skill or training and no inference to the contrary should be made. EWA may only transact business in those states in which it is registered, notice filed, or qualifies for an exemption or exclusion from registration or notice filing requirements. Complete information about our services and fees is contained in our Form ADV Part 2A (Disclosure Brochure), a copy of which can be obtained at www.adviserinfo.sec.gov or by calling us at 888-478-1971. 

The S&P 500® Index (S&P 500®) is widely regarded as the best single gauge of large-cap U.S. equities. The index includes 500 leading companies and covers approximately 80% of available market capitalization.

The MSCI Europe Index captures large and mid-cap securities from 15 developed markets in Europe. The index covers approximately 85% of the free float-adjusted market capitalization across the European developed markets equity universe.

The MSCI EAFE Index is designed to represent the performance of large and mid-cap securities across 21 developed markets, including countries in Europe, Australasia and the Far East, excluding the U.S. and Canada. The index is available for a number of regions and market segments/sizes and covers approximately 85% of the free float-adjusted market capitalization in each of the 21 countries.